Mumbai: Grace E. Koshie, secretary to the board of Reserve Bank of India, or RBI, and custodian of a wooden box that contains a scroll, will open the container on Friday for D. Subbarao, the 22nd governor of India’s central bank.
Subbarao will take the oath of secrecy by signing on the scroll before he assumes the mantle from outgoing governor Y.V. Reddy.
Going by convention, four deputy governors of the RBI will come down to the portico (their offices are on the 18th floor of the bank’s headquarters on Mint Road) to receive the new central bank chief and escort him to the governor’s office on the same floor. After an exchange of pleasantries and a ceremonial cup of coffee with his successor, Reddy will hand over charge to his successor and say goodbye to his office.
Subbarao, 59, an officer of the 1972 batch of the Indian Administrative Service, or IAS, is the seventh finance secretary to become governor in the central bank’s 73-year history. He is also the 11th bureaucrat to don the governor’s mantle—seven of them from the erstwhile Indian Civil Service and four from the IAS.
Passing the baton: Newly appointed RBI governor D. Subbarao (left) being congratulated by his predecessor Y.V. Reddy at a function in New Delhi on Wednesday. Lakshman Iyer / PTI
He is, however, the first RBI governor born after independence. An alumnus of the Indian Institute of Technology Kanpur and an economics PhD from Andhra University, Rao topped his batch of the IAS.
Five years ago, when Reddy came to Mint Road in Mumbai, cutting short his stint at the International Monetary Fund in Washington, DC, all economic indicators were in the pink of health. Inflation was well below 4% and interest rates were at historic lows.
And, just a week before Reddy took over, global rating agency Standard and Poor’s raised the outlook on Indian banking from negative to stable, recognizing the improvement in its quality of assets, higher profitability and better capital adequacy ratio.
Reddy’s legacy is an inflation rate that has more than tripled from five years ago to 12.34% and a tight monetary stance that has pushed up interest rates and the cash reserve ratio, or CRR, the portion of their deposits commercial banks need to keep with RBI.
In fact, since he took over, Reddy has not cut rates or the CRR even once. Since the beginning of this fiscal year on 1 April, he has raised in phases the policy rate by 125 basis points and the CRR by 150 basis points to 9% each. One basis point is one hundredth of a percentage point.
His fight against inflation has slowed the pace of growth in the world’s second fastest expanding economy. In the first quarter of fiscal 2009, the economy grew 7.9%, the slowest since 2004.
Does it mean Reddy failed as a governor? No, even his severest critics would say. In fact, the economic scenario would have been worse had he not raised rates and aggressively squeezed liquidity out of the banking system.
Given the choice, he would have perhaps increased interest rates even more. Reddy could not do so because of the finance ministry’s concern that higher borrowing costs would dent economic growth.
That is the biggest tragedy of the Reddy era—a widening rift between the banking regulator and the finance ministry. The conflict between the regulator and the ministry never became so open. Almost every policy rate hike by Reddy was followed by the finance ministry asking banks not to raise lending rates so as not to hurt economic growth.
Interest rates are not the only issue on which the RBI under Reddy and the finance ministry did not see eye to eye. In January 2005, Reddy’s comments at an academic discussion on monitoring the “quality and quantity” of inflows by foreign institutional investors, or FIIs, into the Indian market provoked finance minister P. Chidambaram to promptly clarify on television channels that there was no proposal to cap portfolio inflows or tax them. Since then, there have been many occasions when Chidambarm challenged Reddy’s assumptions openly or in closed-door meetings with bankers.
Subbarao’s biggest challenge will be to bridge the communication gap between the banking regulator and the finance ministry. He is capable of doing it. “Subbarao is an ideal choice,” says Vinod Rai, his former colleague and now Comptroller and Auditor General of India, who has seen the incoming RBI governor from close quarters. “He takes decisions and is known for his leadership.”
None questions Reddy’s intellectual honesty and monetary management skills. But that’s only one aspect of his five-year regime. He was also instrumental in making local banks stronger by forcing relatively smaller banks to infuse fresh capital, diversify their shareholding structure and even merge with other banks in the past four years.
One area in which he did not live up to the expectations of many is market reform. The original reformer who, as joint secretary of economic affairs, charted out the transition of India’s exchange rate system from a fixed-rate regime to the current-account convertible one in the 1990s, Reddy was extremely conservative in allowing banks to deal in derivative products such as currency and interest rate futures.
But this approach to complex, exotic derivatives and unbridled growth could help ring-fence the Indian financial system against the sub-prime crisis that has rocked the financial world and battered some of the world’s largest financial intermediaries.
The battle against inflation would be Subbarao’s short-term goal. Market reforms and liberalisation of Indian banking will be on his agenda once inflation comes down to RBI’s tolerance level.
Here deputy governor Rakesh Mohan, a seasoned RBI hand, can play a crucial role. If Mohan, who many believe was a strong contender for the governor’s post, chooses to leave Mint Road, Subbarao needs to find an able deputy. Reddy’s immediate predecessor, Bimal Jalan, had Reddy as his deputy to help him oversee monetary policy and market developments; and Reddy had Mohan next to him. Who will Subbarao pick as his deputy?
The market is keenly watching this even as suspense builds up over Mohan’s next move.