Raghuram Rajan begins with a bang

Raghuram Rajan has hit the ground running. He has done well to begin his tenure as governor of the Reserve Bank of India (RBI) by clearly stating what he intends to do in the months ahead. Rajan has been put in charge of monetary affairs at a very difficult time, so his most immediate task will undoubtedly be to deal with the storm clouds that hang over the Indian economy. But parts of the agenda that he outlined on Wednesday—such as the appointment of a group under deputy governor Urjit Patel to take a closer look at the operating framework of monetary policy—suggest that he will also be focused on structural reform at the Indian central bank. The time frames he has announced mean that this is not blue-sky thinking, but a concrete reform plan.

Prime Minister Manmohan Singh had already provided a few pointers about what Rajan should be doing, in his remarks on 17 August, when the fourth volume of the history of the Indian central bank was released. Manmohan Singh admitted that he came to Mumbai with very little knowledge of monetary policy, but later appointed a committee headed by Sukhamoy Chakravarty that brought Indian monetary policy into the modern era. The Prime Minister said that fresh thinking is once again required at RBI.

RBI is one of the most credible institutions in India, even though some of that credibility has been dented by the persistence of high inflation as well as the botched defence of the rupee in recent weeks. Much of the blame for our current economic woes can squarely be laid at the doors of the government, but what is even worse is the way there has been a concerted attack on professional institutions such as the central bank. Subbarao did well to stand up to pressure from the government. Rajan will have to do the same—perhaps to a greater extent in case the next general election throws up an unstable government with strong incentives to buy votes through profligate spending. Running monetary policy during a fiscal dominance is never easy, but it is quite likely that Rajan will have to bear an asymmetric burden in the coming years.

Another challenge will be better communication. Dutch economist Jan Tinbergen had provided a neat rule for economic policymakers: there should be at least one policy instrument to control each policy target. The events of the past few weeks have confused markets. It was never clear whether RBI was using one instrument (interest rates) to simultaneously target two goals (inflation and the exchange rate). At least some of the lost credibility in the financial markets will have to be reclaimed by Rajan.

RBI was once scoffed for its eclecticism because it never bought into the fashionable global consensus that central banks should have inflation control as their sole nominal target and the manipulation of short-term interest rates as their only policy tool. The committee on financial sector reforms, headed by Rajan, had once reflected this failed consensus. The world has since moved closer to RBI view. The point here is that Rajan has as much to learn from RBI as the central bank has to learn from him, so how he reaches out to the organization will be very important.

Finally, one of D. Subbarao’s stellar achievements at RBI was to make a special effort to communicate its policies to ordinary citizens, through an outreach programme that he led from the front. Subbarao believed that a central bank in a democratic society cannot function like an exclusivist temple. Rajan would also do well to sharpen communication with the financial markets, especially at a time when economic stability is so heavily dependent on the expectations of equity, bond and currency traders.

The challenges before Rajan are thus many. He has to stabilize markets in the coming weeks. He will have to protect the independence of RBI from undue government interference. He is the right person to bring in fresh thinking on monetary policy without being dismissive of the stock of knowledge at the central bank. He will also have to continue to make RBI relevant to the country.

It is a tall task, but there can be no doubt that Rajan brings immense intellectual prowess to the job. He has got off to a good start.

What is the first problem that Rajan should tackle? Tell us at views@livemint.com