To begin with,the new RBI governor must re-energise the institution he presides over
The Reserve Bank of India is tasked with three impossible mandates: contain inflation,preserve domestic financial stability and manage Indias external financial account. These tasks are impossible because the governments actions are overwhelmingly influential,narrowly circumscribing the RBIs role and often rendering it largely irrelevant. The new practice of appointing an RBI governor for a mere three years is another expression of the governments domination. Occasional skirmishes notwithstanding,the RBI has responded by kowtowing to the government and allowing its own human capital to atrophy.
Consider inflation. In 2009,the government injected a large fiscal stimulus to protect India from the teetering world economy. Whatever the merits of that stimulus,fiscal deficits have since become endemic,as has the inflation they have fostered. This is a politically stable outcome: self-reinforcing government and business interests have converged on keeping the deficits and inflation high. Higher deficits stoke inflation,which miraculously diminishes the real value of the governments debt obligations. Hence,the large deficits allow a seemingly endless largesse to spread around and yet,the public debt-to-GDP ratio continues to fall. In its latest assessment,the IMF concludes that,based on currently planned measures,high deficits will persist. Meanwhile,infrastructure,necessary to increase the economys supply potential,languishes.
If the RBI raises interest rates to lower inflation,it further damages domestic demand,which is already weak. Car sales have been sliding for months and private investment is in the doldrums. Moreover,higher interest rates provide no assurance of denting the entrenched inflation. Lower interest rates may well spur demand,but supply bottlenecks could add to inflationary pressures.
Or take financial stability. The central problem is that public sector banks are saddled with untold bad debts. The government has repeatedly injected capital to prop them up,and more such injections are imminent. If the premise is that public sector banks are the key to the economic empowerment of the underprivileged,then the banks are principally a fiscal instrument. The RBI has no role to play.
While the RBI has been marginalised in the conflicts on inflation and domestic financial stability,on managing external accounts,it has aligned itself with the government. In the good years between 2000 and 2008,the RBI accumulated large foreign exchange reserves. Its then stewards will rightly claim some credit for that achievement,but the times were propitious and money flowed in everywhere.
Since 2009,the government and the RBI have together supported a strong rupee policy,a policy that has been redoubled since the rupee began its recent slide. With all signals that India has passed a threshold loss of competitiveness,the efforts to prop up the rupee are only building new vulnerabilities. Foreign exchange reserves are declining and short-term debt,which can reverse on a dime,is a growing source of funding external deficits. Such vulnerabilities should be anathema to a central bank.
Raghuram Rajan,the newly appointed governor of the RBI,is perhaps the foremost Indian economist of his generation. As the first winner of the Fischer Black Prize,awarded to a preeminent financial scientist,he is one of the foremost financial economists of his generation,period. He has worked in the most rarefied policy circles internationally and in India. And,from his time as chief economist of the IMF,he is known to be a skilled manager and negotiator. These are formidable gifts. What might he make of them if his options are so constrained?
Another distinguished scholar-policymaker,Rakesh Mohan,wrote of the pre-liberalisation era as a period in which the emperor had no clothes. The problems were there for everyone to see but the willingness to call them as such was absent. It took the 1991 crisis to recognise the emperors state of undress. Can we confront our true liabilities on this occasion without the economy being brought to its knees? As a nation,we are inclined to rest our hopes on individuals. The phrase rebooting the economy has been associated with Rajan. Such hopes are almost always misplaced.
But Governor Rajan has the opportunity to speak truth to power. He can help depoliticise the debates. He can highlight the vast inefficiencies in public finances that hide behind the façade of populist giveaways,the inefficiencies that reflect an incestuous government-business nexus. He can speak the unspeakable on the inevitable privatisation of public sector banks. He can call for a shift from a strong rupee policy to one where the rupee is more competitively valued or even undervalued. He can push for limiting the inflows of short-term foreign currency debt,riding the recent international respectability of capital controls.
But if he did this only by leveraging his stature,it would be a wasted opportunity. The challenge is to harness the potential and morale of the RBIs staff. The RBI once boasted of such distinguished officers as K.N. Raj,K.S. Krishnaswamy,Dharma Kumar,Anand Chandavarkar,V.V. Bhatt,and Deena Khatkhate. Nurturing their scholarship was a credit to the RBI and a gift to the country. As the RBI has slid into anonymity,other central banks have taken big strides towards the frontiers of economic research and policy. They have invested in their staff and new ideas,generating a public good of enormous value. Will Governor Rajan lift the RBI as an institution? Where his distinguished predecessors have been complicit in the slide,will he have the energy,patience and time to change course?
In assessing his performance when the time for that comes,my check list will include two criteria. Did he raise the level and sharpen the discourse on domestic economic policy? Did he create a more dynamic RBI? If he does well on these two counts,he will have my A grade. If he does more,it will be a bonus. I will be rooting for him to get an A+.
The writer is Charles and Marie Robertson Visiting Professor of International Economic Policy at Princeton Universitys Woodrow Wilson School
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