The Reserve Bank of India governor’s unexpected resignation has created concern among the media, academicians and investors about the continuity of policy. Lack of appropriate transition has been covered, to some extent, by the quick appointment of the new governor. The new governor, being a former bureaucrat, starts his innings on a tough note despite very successful precedence of Dr Y.V. Reddy and Dr D. Subbarao.

In some sense, the whole issue is about the role of the central bank in an economy. Before inflation targeting was formally introduced in 2016, RBI was doing multiple roles which required a high degree of conflict management. They were responsible for growth by managing liquidity as well as interest rates. They took care of the rupee when needed. They contributed in inflation management by adjusting liquidity and interest rates. They borrowed money on behalf of the government to keep them functioning. They also took care of the financial system’s stability by supervising banks and NBFCs. They were doing such a good job that Nobel laureate Joseph Stiglitz made a statement that if Dr Y.V. Reddy was the governor of the US Fed then the sub-prime crisis would not have occurred. In essence, RBI was an all-rounder like Kapil Dev who could bowl superbly when needed, bat splendidly when needed and field spectacularly when required. On top of it he could also captain the rookie team to win the one-day international World Cup. RBI was delivering World Cup- winning performance virtually every time for a long period of time. That extraordinary performance made RBI the go-to-organisation for the government for multiple requirements which were inherently conflicting in nature. Somewhere the adage “don’t repair what ain’t broken" was missed and we shifted to specialisation for RBI. It was like asking Kapil Dev to only bowl rather than contribute with all his talent since Malcom Marshal was a successful bowler.

Post 2016, RBI has been mandated to manage inflation and growth in that order of priority. We copied this idea from the developed economies where this idea has been put into cold storage when required. ECB inherited inflation hawkishness from German Central Bank. During the PIGS (Portugal, Italy, Greece and Spain) crisis, caution was thrown to the wind and trillions of dollars worth of liquidity was pumped in at near zero to negative interest rates to support the euro. During the subprime crisis of 2008, the US Fed pumped trillions of dollars worth of liquidity at near zero interest rates to support the crashing US financial system. Bank of Japan has been doing the job of supporting the economy with more than ample liquidity and near-zero interest rates since the ’90s. What was told to Asian nations in the 1997 Asian crisis was conveniently forgotten by the western world in 2008 as well as in 2013.

RBI was constitutionally mandated in 2016 to bring inflation around 4% with a leeway of 2 % on both sides. They have successfully brought down the menace of inflation. It is important to not only bring down inflation but also inflationary expectations. Indians, who are used to double-digit inflation for years, need to see inflation in lower single digit for sufficient period of time to get convinced. RBI has maintained tighter liquidity and higher real interest rates to control inflation as well as inflationary expectations and started convincing Indians at large. The collateral damage has been on growth as liquidity remained tight and the cost of liquidity remains high in the real sense. The disruption caused by the introduction of GST and demonetisation added to the complexity. However, it was a must to pay that price to anchor inflationary expectations. This is what Paul Walker did in the ’80s to break the back of inflation in the US and build the brand of the US Fed as the inflation slayer. The US was at a different level of growth like the almighty West Indies team of the ’80s. It didn’t matter to them if Malcom Marshall only bowled and didn’t contribute with his bat. India is at a different stage of growth and requires contribution from Kapil Dev for batting, bowling, in field and as a captain.

As stated earlier, RBI has been mandated to manage inflation and growth in that order of priority. They have won the war on inflation and are in the process of winning the war on inflationary expectations. However, there is a price to be paid for the same in terms of below-potential growth. What we require at this point of time is the old RBI that is an all-rounder rather than a specialist. They have to manage multiple roles. They have to manage inherently conflicting issues like inflation, growth, rupee and financial system stability.

The current governor has his task cut out to sustain RBI’s credibility and reassure everyone that Kapil Dev’s value is greater as an all-rounder than as a specialist bowler. I am sure that RBI as an institution under the leadership of the new governor will come together to continue doing great service to the Indian economy.

Nilesh Shah is managing director, Kotak Mahindra Asset Management Co. Ltd

Close