RBI is a monetary authority, and sets policies in the fields of money and finance, and it is in that capacity that it provides leadership in thought and policy. The responsibilities relating to foreign exchange management, regulation of financial markets and banking have been given to it under separate legislations or notifications. RBI lends its credibility, expertise and independence in the discharge of the regulatory functions assigned to it. The Preamble to the RBI Act describes its basic objective as, ?to regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in India and generally, to operate the currency and credit system of the country to its advantage.?
In the 1950s and even in the 60s, RBI used to provide intellectual leadership to the central banks in the world, particularly in the developing world. There was a richness of research material and articles by RBI executives that used to appear regularly in international journals. Most of the executive directors of IMF used to be from RBI during these decades.
The 60s witnessed the ascendancy of centralised planning, which gave a distinct and unique role to RBI. In particular, it took notable initiatives for expanding credit to rural areas. With nationalisation of banks in 1969, banks became virtual instruments of government policy. Increased recourse to debt as well as monetisation of debt became the order of the day. Administered interest rates prevailed.
Throughout the 70s, government used to have the dominant role in public policy and even economic thinking in India. For RBI, to carve out its own autonomous policy or regulatory role, the 70s were in a sense a lost decade. Frankly, RBI then had to depend on the Central government even for all policies relating to recruitment of and salaries for its staff. Problems with such arrangements were recognised in the 80s. What was in question in the 80s was the magnitude and quality of influence of government in central banking.
In the early 80s, a committee headed by Dr S Chakravarthy and ably guided by Dr C Rangarajan laid the intellectual framework for a monetary policy and acceptable level of inflation consistent with needs of growth and stability. As a result of these deliberations, foundations were laid for development of money markets by the mid-80s. There was a special recruitment of economists by the central bank and focus shifted to research once again. In the next ten years, RBI developed an enviable pool of in-house expertise on subjects relevant to its efficient functioning.
The collapse of trade with Russia and the Iraq war triggered what we call the Gulf crisis of 1991. RBI seized the initiative for managing the crisis amid the political uncertainty that prevailed. Thanks to the leadership of Mr S Venkitaramanan, the central bank was in a position to guide all concerned on what was the best way out of the crisis. This experience strengthened the de facto autonomy of the central bank, particularly in reforms in areas of monetary management and financial regulation.
As opposed to the pre-1991 situation, the latter period saw more effective communication and a broad-based consultative approach to policymaking between the central bank and the government. RBI?s opinions gained respectability and started to significantly impact markets and gain public credibility. Under Dr Bimal Jalan?s leadership, RBI provided policy leadership with what were then known as unconventional policies to withstand the Asian crisis, the US sanctions, Mexico crisis etc, strengthen the financial sector and release India from forex constraints.
RBI and the Central government acted cohesively to make the financial and external sectors more efficient and resilient through well-thought reforms. While the (governor) Rangarajan Committee was instrumental in improving the management of external sector, the government played its role through industrial deregulation. There existed very close coordination between RBI and government?as reflected in the (governor) Narasimham Committee and the (governor) Malhotra Committee.
If the financial and external sectors in India have become more resilient in the last one and a half decades, credit should certainly go to RBI?s intellectual leadership. Recently, Paul Krugman referred to the dangers of regulatory reform being driven by participants in financial markets. In the committees on reforms, appointed by RBI or headed by former governors or deputy governors (such as by Tarapore), there was appropriate but not excessive representation of financial markets. Participants in these committees came from diverse backgrounds, thus assuring objectivity and pragmatism.
Unlike several countries that introduced rapid reforms in law relating to central banking and governance in the recent two decades, the Indian experience reflects not only a gradual evolution or adaptation of central banking to new economic realities but also its leadership in reforms of financial and external sectors. Most of the legislative changes that enabled a successful framework for reform were conceived and initiated by RBI. In fact, even the work on FRBM was entrusted by the government to RBI.
The recent global financial meltdown and the emerging wisdom on best practices have once again validated the unique path followed by RBI as a pioneer. Let me illustrate some. Clearly, the focus on inflation alone is not the right policy. Financial sector reforms have been in a calibrated fashion and in sync with reforms in the real sector. Banks are special and their exposures to risky investments should be restricted. Countercyclical monetary and regulatory policies are preferable to benign neglect of asset bubbles. The wisdom of restrictions on short-term credit and, more broadly, active capital accounts management?curbing excess volatility in forex markets?is acknowledged globally. RBI has set precedents for macro prudential and countercyclical policies. Indeed, it pioneered the policy of financial inclusion in India. RBI has not contributed to macroeconomic imbalances. Neither has India?s central bank contributed to financial sector imbalances.
Clearly, RBI?s policy actions are now key inputs to the global discussions on central banking. The global orthodoxy is doubtless in a flux and RBI is emerging as an influential player in the global fora, partly reflecting emerging India and partly due to RBI?s proven knowledge and wisdom. Dr Jagdish Bhagwati, on his recent visit to Delhi, alluded to the possible contribution that RBI could make to the deliberations of the G 20, in view of this record of performances.
The author was the RBI governor from 2003 to 2008