Global turmoil and Reserve Bank of India Governor

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Updated: July 16, 2016 11:02 AM

The country must treat the RBI Governor as an independent actor and not constrain his independence

Government now has an agreement on inflation targets with RBI, but with a growth objective. (Reuters)Government now has an agreement on inflation targets with RBI, but with a growth objective. (Reuters)

The British voted to leave the European Union. Whether Britain goes or stays, the EU will change dramatically.

The opaque bureaucracy, ignorance of national political considerations, increasingly central decision making and the dependence on Russian supplies of oil and gas are bringing in a political transformation.

NATO is not as relevant as it was and Europe, especially Britain, cannot afford the present cost of contributing to it. The US is increasingly involved with the countries in the Pacific region in response to China’s attempt to grab oil-rich islands.

The Middle East is in economic jeopardy owing to falling oil prices and a decline in American imports of oil due to shale and gas discoveries.

The American interventions in Iraq, Libya, Afghanistan, Syria, and its support to Pakistan and Saudi Arabia, have led to the emergence of a virulent fundamentalist ‘Islamic Caliphate’ and terror groups like the Taliban and Al-Qaeda. It has also aided the coming up of a failed state like Pakistan with nuclear weapons that it exports and uses as a threat to India.

This political turmoil has economic consequences of which global free trade might become a casualty. Euro and pound sterling will be badly hit and will be subject to wide fluctuations. Poor economic growth in Europe and Japan will adversely affect trade. Very low interest rates might result in unviable lending and, consequently, weaker bank balance sheets. An easy money policy will enhance liquidity in these countries.

Investment flows to, apparently, stronger economies (like India) will increase. China will undergo economic turmoil as it focuses on internal consumption, reducing corruption and correcting high debts of provinces and state-owned undertakings. The US will remain relatively strong. The decline of the Euro as a globally accepted currency and the restructuring in China will further raise the status of the dollar as a reserve currency. Indian economic and monetary policies must extract maximum advantage from this situation.

India is relatively better placed. It is the “fastest growing economy” (on trumped up figures, yet better than most) with good macroeconomic parameters, but with jobless growth. Politically, India has as legacy from decades of ‘non-alignment’ a relatively comfortable relationship (if not close) with most countries, except Pakistan.

Indeed, with its large and growing domestic market India will be wooed by cash rich nations as a trade and investment destination. But times are volatile and economic management has to be alert and responsive to changing global political, economic and financial conditions.

For three years now, India has had an ideal economist to manage its central bank in Raghuram Rajan.

He is highly respected by academic community, heads of other central banks, international financial institutions, rating agencies, and even the informed public.

The financial and monetary mess Rajan inherited was handled firmly and speedily to great effect. His policies were at times unacceptable to the new Indian government. The view being that he was not bigger than the government. There was little recognition for his successful steering of the central bank which stabilised India’s foreign currency exchange.

The finance minister, more than once, publicly disagreed with him. For instance, on the issue of easing interest rates which Rajan was determined to reduce when he was confident that inflation was under control. Rajan’s public comments on actions to clean up the non-performing assets of nationalised banks must also have upset powerful industrialists with proximity to high levels in the government.

Surrogates to powerful ministers attacked him, and Rajan was ultimately forced to announce his departure as Governor after the first term. Only after that announcement did the PM praise him for his service.

India is now in the middle of a global economic drama. RBI, thus, has a key role to play in preserving currency stability, meeting inflation targets and assisting in continuing growth.

The Modi government has announced its determination to bring down deficits and has kept them within targets. However, the suspicion of many experts in India and abroad is that there has been jugglery in estimating the GDP. It is shown higher than it really is and results in the fiscal deficit to GDP being less than it should have been.

Government has also announced measures to stimulate foreign direct investment and is trying to improve the ease of doing business. PM through his many foreign visits has negotiated significant infrastructure investments from governments (like Japan, China, etc.) as well as private sector.

Mauritius and other similar routes, which for decades enabled financial investments without having to pay capital gains taxes in India, have been closed. Under this route, domestic unaccounted money went to Mauritius and was brought back for financial investments in India. In this way, India received far more FII investment than FDI. Now, the balance can be restored.

Apart from announcing determination to control fiscal deficits, this government has introduced three measures. It now has an agreement on inflation targets with RBI, but with a growth objective. The latter could pose a dilemma for RBI, since government and industry think growth requires lowering interest rates. It could also weaken the central bank’s ability to bring down inflation and keep it that way. With a growth objective added to inflation control, RBI may have difficulty in bringing down inflation as it has been able to do in the past.

While there will always be a debate whether growth in agriculture and industry has been constrained by credit and interest rates or by droughts, poor irrigation, lack of storage, rigid labour laws, red tape, lack of demand, etc, there are additional impediments to growth in terms of infrastructure services, water, roads, affordable housing for labour that government needs to address and constraining the RBI will not resolve them.

Public debt management will now be out of RBI purview and managed by a Public Debt Management Authority (presumably, this will include state governments). PDMA will allow the government to issue as much debt as it wants. It can compel banks to buy bonds at an interest rate it wants to pay. SEBI, and not RBI, will now regulate the inter-bank bond market. This will take away a key monetary policy instrument from RBI. It may also be a case of bad timing as the priority of the central bank was to make the bond markets deeper and more liquid. But populist pressures on government are immense, unlike on a seemingly independent RBI.

We must not place as much reliance on only the obvious solutions to contain inflation. India needs coordinated government policy for faster growth of production and jobs. RBI has a key role in keeping the exchange value of the rupee stable, keeping money supply apace with production growth, and overseeing banks so that they do not allow funds to be stolen or misused by borrowers. But it is the policies and their execution to stimulate investment and production that are most vital.

It is sad that a man of Rajan’s brilliance and accomplishments as Governor was induced to go. But he is just a man and will be replaced. For the country’s sake, government and its many spokespersons must get back to removing the constraints that retard growth. RBI is a necessary actor in economic policy formulation and execution, and the government must coordinate with it. The country must treat RBI Governor as an independent actor and not constrain his independence.

The author is former director general, NCAER, and was the first chairman of the CERC  Views are personal

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