In the hot seat, Raghuram Rajan sticks to the path of independence

The new governor of the Reserve Bank of India, Raghuram Rajan, has lived up to the reputation of an independent head of a central bank. Coming as he did from the Union finance ministry, it was widely expected that Rajan should follow the policy nuances of his past master.

This was a foremost consideration because the tenure of Rajan’s immediate former incumbent was marred by public differences between the Union finance ministry and the RBI.

The fundamental reason for the running battle between the North Block and Mint Street was the divergent views of the two on setting short-term interest rate.

In that battle, while the finance minister had time and again expressed his views in public about the need for lowering interest rates to encourage growth, the former governor Duvvuri Subbarao remained steadfast in either raising or maintaining the rate to fight inflation.

The feud was so bitter that in his relinquishment speech, Subbarao had observed that he hoped that the finance minister would at least some time say that the RBI was so obstinate that he felt like taking a walk — if necessary, walk alone.

This was a reference to Chidambaram’s exasperated remark that if the RBI refused to walk in step with the finance ministry, he would rather walk alone. But then, Subbarao hoped that the minister would at the same time add “Thank God, there was Reserve Bank”.

Against this backdrop, Rajan had walked into the RBI. The expectation was that he would walk in step with the North Block and comply by lowering interest rates as a gesture to encourage growth.

But Rajan did not follow that route. He chose his own path.

It appears he had chosen, as if, to sit before a big size control panel for the Indian economy, fine tuning various knobs and levers to set the pace of the flow of finances and, thereby, activity in various channels. Why this imagery?

Rajan has raised the repo rate — considered the basic policy rate which helps determine the entire gamut of interest rates. This he has done in order to fight inflation; the same line of approach as that of erstwhile governor Subbarao. It may be recalled, Subbarao had raised repo rate for a consecutive 13 times in the course of roughly two years when inflation was rising.

But along with that Rajan had lowered the interest rate on the marginal standing facility. He has done this to make sure, what he claimed: the costs of funds for banks could go down. He had explained that the overall costs of funds were high and the financial sector’s costs of funds have to be brought down.

An example of the implication of high-cost of funds was that other intermediaries like the long-term domestic finance institutions were coming to commercial banks to obtain their funds instead of raising their funding from the market. With overall funding costs going down, he hoped that the domestic FIIs should be able to once again access the market.

Rajan had also eased the rigours of cash reserve ratio (CRR) administration for banks. Thus, instead of insisting on maintaining the CRR at 99 per cent of the requirement, he had allowed banks to maintain CRR at a lower threshold of 95 per cent. The banks had been clamouring for a cut in the CRR so that more funds were at their disposal. But the new governor and his team explained that the incidence of CRR in their overall resources was “peanuts” and that at any rate they had been often maintaining CRR at higher than the required levels.

But then, he had also stated in his vision for Indian banks that they should place less funds into government securities and act as lenders for productive sectors.

With so many adjustments and fine tuning, it is not easy to assess how these countermeasures will work themselves out in course of their kicking into operation. The restrictive implications of the repo rate hike will be matched by the lowering of the MSF rate. These, along with the details of other fine-tunings that Rajan is introducing will determine the overall impact of his credit policy.

But then, what has he let go?

Rajan had deferred his first policy until after the Federal Reserve of USA had announced its decision on curtailing its policy of quantitative easing or bond purchase programme.

Its decision to carry on its bond purchase programme had come as a breather. This had already taken the pressure off the emerging market economies and funds had again started flowing into these countries. India was no exception and the rupee had started recovering immediately after the US announcement.

In that context, Rajan could have taken some calculated risks. He could have possibly introduced a cut in interest rates to signal RBI’s commitment to growth, as overall growth had slowed. As for prices, admittedly price level at the retail levels was rising. But the wholesale price inflation was moderate. More particularly, the manufactured goods prices were sometimes falling and even their pace of rise was very slow.

On the other hand, the industrial sector has been gasping.

Many of the major sectors like mining and metals industries have been  shrinking for the last ten months. The fate of consumer goods and durables didn’t inspire much confidence. So industrial sector needed a push badly and this could have come from the RBI through resetting its basic repo rate.

Instead, Rajan had chosen to be the archetypal central bank governor, die-hard about holding inflation down tightly.

Maybe, that was the case for western economies at some points of time. But is that model suitable for India? Rajan must think over it, maybe at leisure, at his sea facing governor’s accommodation.

The author is a Delhi-based analyst and commentator