The man and the institution

In the past week, Raghuram Rajan received the backing of key Indian industry groups for a second term as the Governor of the Reserve Bank of India. On Thursday, the Confederation of Indian Industry (CII), a leading industry body, said that he has done a "great job" for the country. 

Meanwhile, another influential industry body, Assocham, reportedly said that Rajan’s reappointment should be left to the Prime Minister to decide and that he has an “impeccable track record”. "The kind of media statements being issued about Rajan by senior politicians do not augur well for the country's financial system, which is passing through a challenging time because of unprecedented levels of stressed assets in the banks,” the influential industry body said. It went on to further argue that Rajan had brought in much respect for the Indian financial system during his term as RBI Governor. 

The current governor was appointed by the previous UPA government for a three-year term that began in September 2013. But he has recently been under attack from some quarters in the ruling Bharatiya Janata Party, including its Rajya Sabha member Subramanian Swamy, for what they term as his failure to lower interest rates and boost economic growth. However, earlier this week, Union Finance Minister Arun Jaitley denounced the attack. To the uninitiated, Rajan’s current three-year stint as governor of the Central bank will come up for renewal in September. The decision to extend his stint lies with Prime Minister Narendra Modi. To the Wall Street Journal, Modi said that the decision on Rajan’s reappointment would come up only in September. 

The current consensus seems to be that the NDA government will keep its options open on the second term for Rajan. It has become important to gauge the government’s position in view of BJP’s Rajya Sabha member, Subramanian Swamy’s letter to Prime Minister Narendra Modi last month, which listed out reasons why Rajan should not be given a second term. The senior BJP leader wrote that Rajan's concept of raising interest rates to contain inflation was “disastrous.” Also, bad loans with public sector banks have doubled to Rs 3.5 trillion in two years during his tenure, Swamy said. 

Last week, the BJP leader maintained his line of attack. Accusing Rajan of raising the interest rate to the detriment of small and medium industries, he said that the governor should have known the “inevitable consequence of rising and high-interest rate and his policy was willful and thus anti-national in intent”. His missive on interest rates and bad loans are bereft of sound reasoning. Swamy argues that fighting inflation with high interest rates is disastrous. One of the primary tools that a Central bank has to tackle inflation is its ability to raise interest rates. Turkey recently tried to tackle high inflation with low interest rates. The results were disastrous. After taking over as RBI Governor in September 2013, Rajan raised the short-term lending rate from 7.25 percent to 8 percent and retained the high rates throughout 2014.

This was because when he assumed office, the retail inflation measured by the Consumer Price Index stood at 9.52 percent. He began the process of lowering the rates in January 2015 only after inflation started to subside. Since then, he has cut them by 1.50 percent to 6.50 percent. After these minor changes, the retail inflation stood at a more comfortable 5.39 percent in April. However, it must also be noted that retail inflation accelerated to 5.39 percent in April from 4.83 percent in March. But that was down to a spike in food inflation the previous month as prices of pulses and sugar rose. 

These figures are precisely why the RBI may leave the current repo rate—the rate at which the Central bank lends to commercial banks—unchanged, despite pressure from certain quarters of the industry and the ruling party. The RBI is aiming to contain retail inflation to around 5 percent for the current fiscal. “Rate cuts should not be seen as goodies that the RBI gives out stingily after much public pleading. Instead, what is important is sustained low inflation,” Rajan once said. Retail inflation, especially, food inflation, has a debilitating effect on the purchasing power of both the poor and middle class. The numbers suggest that Rajan has overseen a relatively successful attempt by the RBI to tame it. The notion that small businesses have been uniquely hurt by the Central bank’s interest rate regime is not substantiated by the evidence available. Recent data from the Ministry of Corporate Affairs indicate that small enterprises are in fact doing better than their larger counterparts.

One of the major tasks before of Rajan is to get the public banking sector to complete a cleanup of massive debts and force defaulters to pay up. Swamy’s claim that bad loans have doubled over the past two years under Rajan is laughable. It’s clear that bad loans have doubled only because the RBI Governor has forced the banks to recognise them. For years, Indian banks, especially those in the public sector, have lent rather recklessly to big business without due diligence. Bad loans of public sector banks touched an all-time high of Rs 5.4 lakh crore in FY16. The lack of accountability shown by large corporate borrowers has compromised India’s financial system and raised the cost of acquiring credit. By using their political connections and working the overburdened judicial system, these massive corporate entities continue to default on their loans, without paying the price for it. 

And Rajan sensed the deep rot in India’s banking system early on in his tenure. In 2014, he said that he was working on NPAs. However, it is only this year that he called on the banks to start classifying NPAs in full and go for a “deep surgery” rather than “temporary band-aids”. One criticism of the Rajan-led RBI is that its call for "deep surgery" came late. It’s hard to gauge the reasons why it took Rajan that long to recognise the rot and take harsh corrective measures. But a CEO is only as good as his accounts department. This is probably why he has not lost any real credibility in the public eye. 

However, it remains to be seen whether Modi will allow Rajan to finish what he started. Besides targeting inflation and the banking crisis, he has also announced a slew of policy measures aimed at controlling first the rupee’s fall and then eventually building up forex reserves. These measures seem to have borne some fruit. In April 2016, Indian foreign reserves rose to a record high of US $360 billion from the dismal US $275.5 billion at the start of his tenure, on account of RBI’s continued buying of dollars in the market.

However, Rajan’s importance to the Modi government may lie in something larger. In a recent article, noted columnist and policy guru Pratap Bhanu Mehta wrote: “RBI governors have constraints on what they can say, and what is appropriate for them to signal. But still they can provide some reassurance of a counterweight to government spin. What the government needs to understand is that even in an age of spin, acknowledging bad news might actually enhance your credibility. The premium on the RBI governor is that he is the font of reassurance that someone might actually be willing to state the bad news.” And Rajan has done that more often than not to the chagrin of some in the Modi government. His recent comment on the Indian economy, where he equated all the talk of India as a “bright spot” in the global economy as akin to a one-eyed person in the land of the blind, was a testament to that quality of truth-telling that any government needs. Of course, he later apologised and retracted. But credibility is not generated by constant high praise. As Mehta would say, it is generated by the “confidence that you have the ability to speak the truth”.