This week has been a roller coaster ride, from high profile extradition cases, the resignation of the RBI governor and the results of recent assembly elections. While there has been a lot of focus on the recent assembly elections, the recent appointment of the RBI governor has also got its fair share of coverage. The important thing to note here is that there has been a well-established precedent to appoint a bureaucrat as the RBI’s governor. Thus, the government has only reverted back to what was a normal convention in the past.
Another reason why it is important to understand why a Bureaucrat as the Governor is a well thought out choice is that the key veto power over monetary policy no longer resides with the RBI Governor. Now India has a new Monetary Policy Framework under which there is a Monetary Policy Committee (Of which, of course, the RBI Governor is a member) that determines the Monetary Policy for the country. It is this committee where expert monetarists are required to provide their expertise in terms of taking decisions regarding interest rates or reserve ratios.
That being said, it is well acknowledged that India has one of the tightest of monetary policies and that too at a time where inflation seems to be significantly lower than even RBI’s estimates. Their recent stance of calibrated tightening came as a surprise given that inflation has been low while the economy has consistently been seeking some liquidity to facilitate further growth. The real interest rates in India have been at an all-time high and this has come with India just being at the revamp of its positive investment cycle. Thus, the over-exaggerated fears of inflation have started to impact the growth prospects of the economy in the short term and perhaps this is why there’s a need to review the current monetary policy seriously.
It must be mentioned though that in India inflation is largely driven by food prices and crude prices both of which are not determined by the monetary policy. Food prices are partly driven by the Central Government’s MSP decision and partly by the forces of the market while Crude Oil prices are of course determined in the international market. Thus, the efficacy of the monetary policy on inflation for an emerging market economy like India needs to be subject to academic review. Yes, monetary policy does impact inflation, but the question is till what extent and beyond that, the question is, at what cost to growth does it impact inflation?
It is not that the real interest rates have been the only issue as there has been a recent fall in the growth of priority sector lending and following the IL&FS crisis, it is a well-known fact that the Non-Banking Financial Sector is facing stiff liquidity issues. It is these challenges that had caused a disagreement between the previous RBI Governor and the Central Government as both had their own ways to resolve the current situation.
Given that we’re currently in the low inflation phase, perhaps the change in guard is a blessing as we can take a look at some of the other areas where the RBI needs to work going forward, and a major area would be in terms of its capacity building and getting their inflation forecasts more in line with what the actual inflation figures are. Without sound forecasting, it is difficult to take calibrated policy outcomes. Another important thing that’s required is to improve the efficacy of the regulatory role of the RBI given the recent lapses that have occurred with the Punjab National Bank frauds.
On the NPA resolution front, the RBI has got a friendly North Block which has already passed the Insolvency and Bankruptcy Code that is estimated to resolve up to 45% of NPAs by the end of 2018 while by 2019 a major chunk of the NPAs would be resolved with minimum haircuts for the banks.
While others have focused on the master’s in history that the current RBI governor has, they’ve ignored the sound expertise in administration and policy outcomes that he has developed as an IAS officer. It is these skills and administrative experience that will be of enormous help as he steers the RBI through troubled waters. His courses in Financial Management from IIM Bangalore and series of diplomas in institutional credit will come in handy but more importantly, his experience at the Finance Ministry, first as a Secretary of Economic Affairs, Department of Expenditure and Revenue Secretary will come in handy as he heads India’s Central Bank.
While the task in front of him is challenging, he’s already started his work by addressing one issue at a time so while the critics may still question his appointment, it is his legacy that will provide the final answer to all those who questioned this decision. The man who steered the economy through Demonetization has been put in charge of the RBI; with his impeccable credentials and extensive experience, I am certain he’d only increase the stature of this great institution.
