Rajan’s Will Be A Tough Act To Follow, Successor Will Have His Work Cut Out

The NDA government has not covered itself with glory in the way it is letting go of Raghuram Rajan, who said today (18 June) that he will return to academics once his three-year term as Reserve Bank Governor ends in the first week of September. The problem is not that he is going, it is about the manner and circumstances in which he is going that leaves a bad taste in the mouth.

Rajan has been attacked by a member of parliament in a way in which no other RBI Governor has been, and this will forever remain a black mark on the Modi administration’s visage. It is not that Rajan’s performance is invulnerable to criticism. But personalised attacks on his patriotism and competence, as Subramanian Swamy has done, were totally uncalled for. It is, therefore, right that Rajan has chosen the graceful and sensible way to move on, thus protecting the office from further politicisation and attack. He has done the right thing for the institution he headed with distinction.

Incoming governments, especially those who have been handed a poisoned chalice, have a right to appoint people to key positions based on their own ideological preferences. However, there is a right way to do this and a wrong way. Where a whisper in Rajan’s ear would have done, we had a megaphone screaming about his alleged unsuitability for the job.

The damage has been done. It is now critical that Rajan’s replacement is announced early, and the choice is a credible one. It is particularly important that the choice should be based on competence, and not his pliability. Maybe, this is as good a time as any to put in place a monetary policy committee (MPC) headed by a credible face.

While Rajan has been a good and transparent governor, his decisions are not beyond question. His replacement, whether by one man or a committee, can have a different approach to the job, but the issues remain the same.

First, how effective is the interest rate in checking inflation, While Rajan, in his goodbye note, has claimed success in tackling inflation, it is not clear how much of that is due to higher interest rates, and how much due to the fall in oil prices, fiscal consolidation and decent food supply management (till recently). It is conceivable that the next governor can cut rates as long as the government promises – and delivers – on its fiscal promises and keeps food inflation in check through supply side measures.

Second, how do we fix the bad loans situation in banks? Rajan rightly called for disclosures of the problem, but by keeping rates high, he actually made it tougher for banks to generate higher profits on the treasury front to provide for higher losses. At a time when nationalised banks are poorly capitalised to handle the shock of rising bad loans, it is not clear that Rajan has calibrated his policies correctly. He has made it difficult for banks to raise capital even as the government is forced to limit its contributions due to fiscal constraints. Clearly, the sequencing of bad loan disclosures and capital raising could have been better managed. The next governor has a big challenge on this front.

Third, the RBI has opened up bank licensing for niche and focused banks. He has also offered licences on tap for universal banks. Once again, the timing is the problem. How will nationalised banks, already reeling under an overload of bad loans, compete with new, highly-capitalised and lean payment and other banks, when they will be going after the former’s cheapest fund sources and best retail customers? Allowing competition in when public sector banks are ill-prepared for it is the surest way of creating more white elephants. What happened to Air India and MTNL can happen in banking.

Fourth, the repayment of the dollar deposits raised in 2013 to ward off a foreign exchange crisis due to global turbulence will, presumably, be handled without hiccups. But the next governor will have to take a call on where to let the rupee go, given that exports are in the doldrums, and the stable rupee has made Indian exports even less competitive. Rajan has given himself a pat on the back on how he handled the rupee, but the currency perhaps needs to fall a bit to give exports a leg up.

Fifth, it is important not to hype up the role of the RBI Governor as some kind of superman or superhero. Rajan has been a very high-profile governor, and he has also rubbed politicians the wrong way by airing his views in public, but the job does not need a high-profile man or woman to be effective. Often, a low-profile person can be just as effective.

Consider how Alan Greenspan’s stewardship of the US Fed was hailed as beyond compare, when it took only one subprime crisis to undermine that reputation.

The US Fed Chair is one of the world’s most hyped up jobs, when it need not be. The past three incumbents have hardly done anything to distinguish themselves as anything special. Greenspan’s two successors have done little more than keep money cheap and funds slowing like water. This is pretty much what the European Central Bank and the Governors of the Bank of Japan and the Bank of China have been doing.

By doing something different, Rajan has helped India’s monetary management stand out. But standing out when the world is plunging into currency wars has its own costs. It will take years to know whether standing out was a wise thing to do or something to be avoided.

Now that he is going, it is better to take the spotlight away from one man and move it to a monetary policy committee (MPC), where several heads will hopefully do at least as well as one man.

Rajan’s critics may well rue their ad hominem attacks on the man. By making it impossible for Rajan to stay, they have made the job tougher for his successor, who will now be judged not on his own competence, but how he will stack up against Rajan. For several months, the successor will operate in Rajan’s shadow.