Assessing Subbarao’s first year as RBI governor

Assessing Subbarao’s first year as RBI governor

RBI insiders find him a central banker who is “down to earth" and “open to ideas". They have not seen too many governors walking into deputy governors’ offices at RBI headquarters, located on Mint Road in Mumbai. Most of his predecessors used to summon deputies to the corner room.

Bankers love his “listen to all" approach. Until he took over, RBI monetary policy meetings were a ritual where the governor talked and chiefs of commercial banks listened. Now every chief executive—of big, medium and small banks—gets an opportunity to present his/her side of the story. They even argue with the governor. Bond dealers find him “transparent" and “friendly" and willing to communicate with the market. Almost every month he meets the primary dealers who buy and sell government bonds and tries to understand their concerns. He does this with all “sincerity" as he needs to see through a massive Rs4.5 trillion government borrowing programme this fiscal. It’s another matter that the yield on the benchmark 10-year bond, which dropped to below 5% in January, is now hovering around 7.5%. Bond dealers are not making money any more, but they aren’t blaming Subbarao. After all, he has been been making the right noises on the government’s rising fiscal deficit.

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Economists and analysts too seem to like his intellectual honesty, evident in his statement, “Financial stability is like pornography. You can’t define it but when you see it, you know it." Subbarao first used this at an RBI central board meeting when finance minister Pranab Mukherjee pointed out that the Act that governs the Indian central bank has no reference to the concept of financial stability. Subbarao repeated this at a public forum in Hyderabad in a different context.

Indeed, the current RBI governor is very different from his predecessors. More than a month before he took over, when he was serving as India’s finance secretary, I had asked him whether he would like to head RBI. He was candid enough to say that given a chance, he would love to take up the challenge. Even after taking over the assignment, he has not lost this candidness. At the height of the global financial crisis, in one of our rare informal meetings, Subbarao told me he would love to go out of his office and visit the industrial belts to see the real impact of the crisis. “RBI does fantastic research work. It has every data to catch the trend but I feel I should go out to get a first-hand experience of what is happening in the economy," he said.

To use a well-worn cliché, his first year in office has been tumultuous by any yardstick. A week after he took over, Wall Street investment bank Lehman Brothers Holdings Inc. collapsed, plunging global financial markets into an unprecedented credit crunch. He took a few weeks to appreciate the gravity of the situation, but once he got into the act, he was nimble-footed and did everything that a competent regulator should do to ring-fence the Indian financial system from the meltdown. He brought down the policy rates from 9% to 3.25%; the cash reserve ratio, or the portion of deposits that commercial banks need to keep with RBI, from 9% to 5%; and the floor for banks’ investment in government bonds from 25% to 24%. His policy measures generated at least Rs5.6 trillion of liquidity to fight the credit crunch and lift a sagging economy. I would give him 10 on 10 for crisis management. But now will be the real test of his mettle. This is because at the hour of crisis, for every decision he took, he had the backing of the finance ministry. But with early signs surfacing of an economic recovery and a rise in inflation, the central bank and the ministry may not speak the same language any more.

In July, Subbarao signalled the end of an expansionary policy regime by leaving key policy rates unchanged. He also raised projections for both growth in India’s gross domestic product as well as inflation. While the growth target for the current fiscal year remains at 6% with an “upward bias", the forecast for year-end inflation has been raised from 4% to 5%. Inflation is rising fast and analysts are expecting it to reach 7-8% by March next year as the base effect, due to higher commodity prices last year, gives way quickly. This may prompt Subbarao to raise interest rates and tighten monetary policy earlier than the government expects him to do. The governor has also been talking about withdrawing the monetary accommodation that he had provided as money in plenty stokes inflation, but will the finance ministry allow him to do so unless the economy is on a firm growth path?

The governor’s honeymoon with the finance ministry will be over sooner than later. The monetary policy stance is one of the many issues that will pitch one against the other. For instance, the government wants RBI to allow greater foreign play in the bond market and leave the task of managing its debt to a separate agency. If he succumbs to the pressure, Subbarao will be seen as a weak governor and if he fights it, he will lose the confidence of the ministry. The balancing act is an art that not many governors have been able to master.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email comments to