Rexit: When Raghuram crossed the Lakshman rekha

20th Jun 2016
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The outgoing Reserve Bank of India (RBI) governor Raghuram Rajan didn’t do what the government asked him to do. Expectedly, the Modi government was upset and showed him the door. This isn’t the first such instance. This won’t be the last, either. In fact, the government and the RBI have been at loggerheads for the past eight decades of the central bank’s existence. Even the very first governor, Osborne Smith, was booted out (the reasons are not well-documented, though).

raghuram rajan at World Economic Forum

Interestingly, India’s first Prime Minister, Jawaharlal Nehru, who is often credited with laying the foundations for several autonomous institutions in an infant democracy, refused to support the then RBI governor Benegal Rama Rau. He had sought his help against the incumbent flamboyant Finance Minister T T Krishnamachari or TTK, who openly termed the RBI a "subordinate office" of the finance ministry. Of the 23 governors the RBI has had since its inception, five were sacked by the government of the day.

To put it simply, the RBI is independent only within the bounds set by the incumbent government. That’s why those crying foul (including Congress Vice President Rahul Gandhi) need to take a crash course on the RBI’s history, which tells us that an RBI governor ran into trouble over Maruti’s (the brainchild venture of Sanjay Gandhi) credit limit. Even the short-lived Janata Party and Chandra Shekhar governments had had their own share of run-ins with the RBI.

It’s not the clash of individuals, stupid…

…it’s the clash of mandates. In Ramayana, the mandate for Sita was not to cross the Lakshman rekha, but she did, based on her own thinking and judgment, and not because she wanted to disobey Lakshman’s instructions. Similarly, Lakshman left Sita behind to go and look for Ram on Sita’s insistence, despite Ram’s instruction to not leave Sita alone. In economic terms, while the mandate for the finance ministry is to boost growth and employment, the role of the RBI is to keep inflation in check.

It’s about perception: Whether right or wrong is immaterial

The problem is, in most cases, similar to the Ramayana episode, the mandates are contradictory. The government of the day believes that Rajan isn’t doing enough for the economy by keeping interest rates high and, in turn, dampening growth. The RBI under Rajan has remained committed to keep inflationary expectations under check and gradually create conditions for sustainable growth. Who’s right or wrong doesn’t matter. What's important to note is that the finance ministry thinks that Rajan is at fault.

Could Rajan have cut interest rates further? Sure.

But even that wouldn’t have guaranteed faster economic growth. The US and Japan are clear examples. Rather, such accommodative policies often tend to create bubbles. In addition, Rajan’s idea of a 200 basis point real interest rate on a one-year Treasury Bill made the government—which is also the largest borrower in the country—see red, as such a move would have significantly inflated the borrowing costs. On the other hand, the banks could not pass on the rate cuts to the consumers, on fears of becoming uncompetitive in the deposit mobilisation market, where the government offered a higher interest rate through Employees' Provident Fund (EPF) etc.

Communications beyond the mandate

Central bank communications are closely scrutinised worldwide. Whether it’s the US Fed’s meeting minutes, or the RBI’s policy review statement, analysts and journalists alike tooth-comb every sentence, phrase, punctuation and tone for signals. As a “free thinking” and “rockstar” economist individual, Rajan is entitled to his views, but dissemination of such views need to be weighed on a different scale. That’s why Rajan himself is responsible for making his position at Mint Road untenable, by expressing his views on myriad issues – from the GDP calculation method to the fast-paced rollout of Narendra Modi’s flagship Jan Dhan scheme.

Institutions should always be above individuals

Be it an individual as talented as Raghuram Rajan or whosoever, no one is indispensable in the bigger scheme of things, as India doesn’t have a dearth of talent and the government may have someone in mind who’s equally, if not more, talented than Rajan. Finally, let me remind the so-called pseudo-socialists shedding crocodile tears at Rajan’s departure, that Rajan is every bit of a capitalist hailing from the University of Chicago Booth School of Business, where free market champion Milton Friedman’s influence looms large.

Finally, I strongly believe that had Subramanian Swamy not launched his anti-Rajan public rants, there would not have been much hue and cry over Rajan not getting a second term. Swamy is a loose cannon that Modi should use very sparingly; else, the consequences could be disastrous.

In 2004, Rajan had coauthored a book with his fellow Chicago Booth professor Luigi Zingales titled Saving Capitalism from the Capitalists. The need of the hour is to save India not only from the crony capitalists and crony socialists, but also from the crony nationalists.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)

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