Some recent events would appear to have tested RBI Governor D Subbarao?s somewhat soft and self-effacing leadership style at the central bank. He had to discipline one of his deputy governors who seemed to publicly disagree with RBI?s decision to ?not raise interest rates enough? to attack inflation more effectively. The Governor also faced a lot of pressure from within RBI to take a public stand on the recent ordinance issued by the finance ministry, which appeared to lower the central bank’s institutional stature. Subbarao?s response in both instances showed his unique way of negotiating matters with the fiscal authorities, on the one hand, and his own team at RBI, on the other.
Subbarao has a personality type that is very different from many RBI governors we have seen in the past. For one, he has a great sense of humour and even displays an ability to laugh at himself. Normally, central bank governors are burdened by the need to appear somewhat grim and decisive, without any self-doubts, because they must be seen as leading the perception game in the financial markets. This is a sort of behavioural stance that most central bank governors have to maintain.
Subbarao has been somewhat different in this respect. Unlike all previous RBI governors, he is extremely consultative and likes to debate critical issues with the widest range of constituents, whether money market traders, bankers, economists or other small and big businessmen. Subbarao is the first governor to have started structured interactions with these groups, prior to major monetary policy reviews, in order to get a wide array of opinions. He even surprised RBI brass by inviting for discussions some people who were the bitterest critics of the central bank and its way of functioning.
Some top RBI officials may have initially wondered why the new Governor was being so democratic and participative in his decision-making. For RBI?s DNA was never known to be so open and participative. There is a general sense that RBI bureaucracy tended to have too much faith in its ?technocratic intellectual base?, to the exclusion of other obvious realities that existed around us. There were also other reasons why Subbarao had adopted a more participative approach. He was called upon to steer the central bank in the worst possible period?after the global financial meltdown?when all received wisdom in policymaking was getting turned on its head.
More importantly, he got a serious piece of advice from none other than Prime Minister Manmohan Singh, whom Subbarao had paid a courtesy call just before taking over the reins of the central bank. Manmohan Singh suggested in a somewhat lighter vein that it was easy for central bankers to lose touch with ground realities working from the rarefied space on the top floor of the RBI building on Mint Street. One must therefore keep one?s ear to the ground at all times.
Subbarao appears to have taken that advice very seriously, and has immensely benefited from it. It is becoming increasingly clear that his decision to stay somewhat ?behind the curve? on raising interest rates was a sound one. Without relying too much on technocratic calculations of inflation and real interest rates, Subbarao used his instincts and chose to straddle the middle path. He took only baby steps in raising interest rates in the past year when the inflation rate had gradually gone beyond the double digit, causing a big scare that it would derail the economy. However, growth in recent months has been quite robust. His call was proved right, in a sense.
He recognised that in the initial phase last year, the higher inflation rate was largely driven by rising food prices. He is the first central banker to have openly declared that food inflation caused by supply shocks is beyond the pale of monetary policy. Last week, he said in Hyderabad that ?food items have 46 to70% weightage in various consumer price indices and were notoriously subject to supply shocks which are normally beyond the pale of monetary policy?.
His recent policy initiatives have shifted focus to making monetary transmission more robust, which is a bigger priority for the central bank. You can go on raising interest rates but if the transmission mechanism is not good enough, what use is it? His approach shows a great deal of pragmatism.
While using the repo rate to signal tighter money, RBI is simultaneously using the new base rate mechanism to force banks to lend short term at higher interest rates. By not allowing banks to lend at below the base rate, RBI has ensured that the interest on three months commercial paper has gone up substantially?by about 1.5% in recent weeks. This is all about strengthening the transmission mechanism. Subbarao seems to be on the right track, in this respect.
The Governor also spoke up at the right time when the recent ordinance to resolve inter-regulatory disputes appeared to threaten RBI?s institutional autonomy. He met the finance minister and expressed his viewpoint politely. The finance minister responded and made necessary changes in the law, giving RBI its due. Subbarao has done well to resist getting too confrontationist with the fiscal authorities, much as RBI bureaucracy might want him to. His soft and affable style works, for the most part.
mk.venu@expressindia.com