Time for speculation is over. The term of the 23rd governor of the RBI Raghuram Rajan is set to end in 75 days. So, how does his era compare with that of his past four predecessors since liberalisation? The pride of place may still go to C Rangarajan for the quantum of changes that came about during his tenure: rupee became convertible in the current account; a true foreign exchange market was born; the government’s endless borrowing from banks came to a stop and a government bond market, however distorted, was born; RBI stopped setting bank lending rates and banks were given the freedom to set their deposit and lending rates leading ultimately to more market-driven banks.
Compared to Rangarajan, the changes during the tenures of governors Bimal Jalan, YV Reddy and D Subbarao were more incremental, even if seminal.
The Rajan era showed promise of resetting India’s financial sector. The repositioning of the RBI as primarily an inflation-fighting central bank was the first tenet of Rajanomics. Rajan did it with all the paraphernalia. He correctly changed the inflation anchor from wholesale price index to consumer price index, put in place a monetary policy framework agreement (MPFA), and got the government to give the RBI inflation targets every few years. The current government by signing the Monetary Policy Framework Agreement (MPFA) has not just told RBI to keep inflation below 6 percent, it has tied itself, too, to that target. The question to ask now is: will the CPI anchor, the 6 percent intolerance limit and the monetary policy framework survive? Here the answer is a qualified yes. To be sure CPI will remain the inflation anchor. It will be impossible, and thankfully so, to switch to WPI now.
Of the 6 percent CPI limit surviving as a moral pressure, there is less certainty. Much depends on the next governor and the broad community of economists, business journalists, financial investors and the government. If foreign bond investors along with domestic business intelligentsia keep up the pressure, a valuable institution will be created. India’s average WPI over the last 70 years has been 7.5 percent and its CPI -industrial workers (since the current unified CPI is of recent origin) has averaged 8 percnt. So a sub-6 percent CPI hereafter will be a true achievement of the Rajan era, provided future governors and governments allow the MPFA to survive in its current form.
The Monetary Policy Committee (MPC) is another idea of the Rajan era that is now written into law. Will the MPC be created? Will it be a successful experiment? Will India graduate from a one-man interest rate setting economy to a committee doing that job, as is done in advanced countries? The jury is still out.
On the banking side, Rajan has taken decisions which may greatly deepen and widen the financial sector. The Unified Payments Interface, the eight payment banks and the eight small banks may all make India’s financial sector more inclusive and exciting. As Bharti Airtel and Kotak; Rel-Jio and SBI; Idea and AB Nuvo and India Post all venture forth and ease payments and create a financial savings culture for the one-billion cell phone account holders of the country, India may evolve into a much bigger, deeper financial power house three years from now. May be then the country may look back and thank the 23rd governor for catalyzing the process.
Rajan hasn’t put banking licences on tap yet. But he has paved the way and still has 75 days to firm up the rules. If this is done, on-tap bank licensing will certainly be a contribution of the Rajan era.
Rajan’s other achievement in the banking space is to boldly uncover non-performing assets or NPAs. Future governors will have to live up to his bold act. Here again the jury is out. With the new instruments to write down unsustainable loans and move forward by providing for them or selling the indebted companies, Indian banks may emerge as a robust sector in the next two years. It is here that Rajan’s task is truly unfinished and a five-year term would have helped.
A few weeks ago Rajan mentioned the RBI is now considering a proposal to accept corporate bonds with suitable haircuts at the LAF (liquidity adjustment facility) window i.e. at the daily repos conducted by RBI. This appears to be still a fledgling idea but has the potential to finally help a corporate bond market emerge.
Rajan’s other ideas that remain fledglings is the TREDs or the Trade Receivables Exchange that would have forced large enterprises including the government to pay up bills of small enterprises on time.
The big lesson from surveying the Rajan era is that RBI governors need to be given five-year terms. That’s the standard length of term given to parliaments, governments and central bankers world over – 5-7 years. Had Rajan been given that full-term he would probably have been able to see all these institutions through: an inflation targeting RBI, a monetary policy committee, institutionalization of a sub-6 percent inflation limit, a robust banking sector that is inclusive and competitive, a reliable exchange for small companies to discount their bills and with some luck even a corporate bond market.
The UPA must probably share the blame for not institutionalizing the practice of 5-year terms for governors. It doesn’t appear that the NDA is in a mood to right this wrong.
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