Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Do Reserve Bank governors need a longer term?

What can you really achieve in three years in a country like India where it takes time to get things done?

With less than six months to go before Raghuram Rajan’s three-year term as governor of the Reserve Bank of India (RBI) comes to an end, the chatter on whether he will get an extension or not has picked up. It is not just journalists who are keeping the gossip circle active, but even respected analysts are engaging in a liberal amount of speculation. Will Rajan get a second term? If not, what does it mean for the currency? And so on.

This is not a piece on whether Rajan will or should get a second term. This is more an argument that the chief of India’s central bank and its banking regulator (whoever that may be) needs a longer tenure to complete any meaningful reforms that he or she chooses to undertake.

Most major economies across the world have given their central bankers far longer terms than what an RBI governor gets. Who can forget the 19-year term that Alan Greenspan served as the chair of the US Federal Reserve. Paul Volcker and Ben Bernanke both spent eight years each at the helm of the Fed. The initial appointment in the case of the Fed is for four years, but most have stayed on well beyond the first term.

The Bank of England, too, has a similar track record. Each of the last three governors—Mervyn King, Edward George and Robin Leigh-Pemberton—spent a decade each at the Bank of England. The governor is typically appointed for eight years although Mark Carney, the current governor, initially agreed to a five-year term (at his own insistence). In a December interview to the Financial Times, Carney suggested that he may stay longer because there was “so much more" he needed to do.

Over at the Bank of Japan, the last three governors have spent about five years each at the helm. That is at par with the trend in India, but the difference is that the initial appointment is for five years.

In India, the norm has been to appoint an RBI governor for three years and then extend that appointment for another two years. In an exception, in the case of Y.V. Reddy, the initial term was set at five years. While most RBI governors have served a five-year term, they have had to seek a reappointment after the first three years, which fuels predictable speculation over the relationship between the governor and the government. We would guess that it also puts the governor under greater pressure.

Is all this avoidable by starting with a five-year term for the RBI governor?

Look at this another way. What can you really achieve in three years in a country like India where it takes time to get things done?

Consider some of the reforms undertaken by the RBI under Rajan. The biggest, from a central banking perspective, has been to move towards flexible inflation-targeting. Rajan wasted no time in getting that process going. It kicked off with the Urjit Patel committee report, which was released in January 2014—about four months after Rajan took over. The central bank moved quickly towards making consumer price inflation the nominal anchor, but it was only in February 2015 that an inflation targeting agreement was signed between the government and the RBI. The plan to set up a monetary policy committee to go with the inflation targeting framework got formal clearance only this week and the panel will likely be formed this fiscal. If Rajan were to leave in September, he would not be able to see through a significant reform that he pushed for.

There are other important changes under way. Under Rajan, RBI has started the process of licensing differentiated banks. Payments banks and small finance banks have been granted licences, and the next step is to consider wholesale banks and custodian banks. Draft guidelines for universal bank licences have also been put out. It would be beneficial for the system if the team that has spearheaded these changes is around to see them to their logical conclusion.

Frequent changes in central bank leadership also have the potential to create uncertainty in the markets. An example of this would be the liquidity stance that the Rajan-led RBI has adopted in the past few years.

Typically, during a rate easing cycle, the RBI would maintain surplus liquidity and allow the reverse repo rate (the rate at which banks park surplus funds with RBI) to become the guiding rate. The current RBI leadership, however, has been of the belief that a liquidity deficit must be maintained to ensure that the repo rate (which is the key signalling rate) remains the benchmark. The RBI’s logic didn’t match the market’s thinking, and we had a year where little of the interest rate reductions filtered through the system. This has now changed, and the RBI has said that it will maintain neutral liquidity. But who’s to say that if the top team at RBI were to change, a different view won’t come in?

This is not an argument for reducing the accountability of the RBI top leadership. By all means, hold them accountable. The governor is accountable to Parliament and can be summoned by its standing committee on finance. Under the new inflation targeting framework, RBI also needs to give an explanation should it fail to meet its inflation targets. But along with maintaining that accountability, we should consider giving the governor a little more time to work with.

Ira Dugal is deputy managing editor, Mint.

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