Mumbai: They say marriages are made in heaven but the relationship between a finance minister and the country’s central bank governor is usually characterised by fire and brimstone. In India, the periods preceding and following the Lehman Brothers collapse in September 2008 highlighted the tension writ into the association and its infuriatingly fraught nature. At another level, this natural antipathy has also informed India’s banking regulatory framework.

Two books by two successive Reserve Bank of India (RBI) governors—Advice and Dissent by Y.V. Reddy, and Who Moved My Interest Rate by successor Duvvuri Subbarao—illustrate the unrelenting pressure both faced from finance ministry to keep interest rates low, as well as adopt an expansive monetary policy, in the fond belief that these were necessary to sustain India’s economic growth trajectory. The only difference between the two was timing—Reddy played his hand before the financial crisis and Subbarao thereafter.

As a consequence of their tenures book-ending the Lehman collapse and their deft handling of the crises, the two governors contributed to the global discussion—especially on multilateral platforms like G-20—on regulation and supervision, including on how to deal with risks arising from systemic issues and inter-connectedness, the need for counter-cyclical macro-prudential policies and the link between macroeconomic and financial stability. However, India perhaps conceded some additional ground later by agreeing to regulation that was custom-built for developed nations but seems inappropriate for emerging markets like India. 

The global financial community feted Y.V. Reddy as a prescient central bank governor because he was able to shield India from the radioactive ripples of the Lehman collapse. But the story before the event looks different: he came in for severe censure from domestic market participants, from global experts and from the political class. He resisted dominant economic wisdom that advocated light-touch regulation and supervision; conventional wisdom favoured a detached regulatory role because it believed that financial markets were sophisticated and had capacity to distribute risks efficiently to those who can handle these risks, that extant risk models were designed to measure risk accurately and that all financial innovations are inherently useful.

Reddy’s prudence, on the other hand, was fashioned from ground conditions with a healthy disregard for imported orthodoxies; he started raising interest rates and reining in excesses (such as, tightening margin conditions or increasing risk weights for real estate loans) 15 months before Lehman became a financial horror story. Consequently, he was viewed—largely by capital market participants—as the lone man standing between the country and its growth aspirations. His relation with then finance minister P. Chidambaram was tumultuous. In his book, Reddy devotes two chapters—titled Working With Chidambaram and Creative Tensions—on working with the finance minister. He concludes by saying: “Chidambaram and I worked closely for four years. Most of our tensions could be described as constructive or discord that ultimately gave rise to better ideas or outcomes."

Reddy’s public disagreement with P. Chidambaram was emphasized in October 2006; RBI’s mid-term review of the 2006-07 annual monetary policy used the term “overheating" 12 times and drew the finance ministry’s ire out into the open. Having cracked the whip on runaway asset prices and inflation, Reddy left RBI on 5 September, 2008, a few days before the Lehman name would become synonymous with caprice, greed and global crisis. But, before walking into the sunset, Reddy had tightened the nuts and bolts, battened down the hatches and squeezed out speculative energy from the system.

Subbarao’s initiation into RBI was marked by Lehman’s collapse. The after-effects washed up in India through the usual channels—trade and financial flows. He worked closely with the government to keep the economy ticking. RBI safeguarded against credit defaults and systemic contagion by ensuring availability of adequate liquidity, lower interest rates and a close watch over the payments system.

On its part, the government launched a massive fiscal stimulus programme to counter the dampening effects of the spreading global crisis, and to prepare for impending general elections in April 2009. Given the Indian economy’s structural deficiencies, the aftermath soon manifested in the form of rising inflation and inflationary expectations. Subbarao started raising interest rates from April 2010 and perhaps set a record by increasing them for another 12 times over the next 15 months.

This, obviously, did not endear him to Indian businesses, capital market agencies or the political class. Subbarao writes in his book: “My refusal to fall in line had evidently upset Chidambaram enough to do something very unusual and uncharacteristic—to go public with his strong disapproval of the Reserve Bank’s stance."

Some economists say that an element of friction, or even antagonism, between a central bank governor and the finance minister—or between monetary managers and the fiscal side—is healthy and should be seen as the natural order of things. In hierarchical terms, Indian central bank governors usually tailor their monetary policies as a reaction to the government’s fiscal initiatives; or, simply told, fiscal leads and monetary policy follows.

The tensions between both sides continued even after Raghuram Rajan took over the governorship from Subbarao in September 2013. Apart from the strained ties with finance ministry, Raghuram Rajan shared another common characteristic with his predecessors: soon after taking office, he had to contend with the taper tantrum. The Indian economy faced widening fiscal and current account deficits, aggravating the effects of financial outflows on the currency. Rajan shared another common trait with the former governors: he also wrote a book on demitting office. Beyond that, he continued to work on tightening prudential norms, impressing the global platforms with India’s unique needs.

Current governor Urjit Patel took over in September 2016 and had to contend with a man-made domestic economic crisis: demonetization. He had little choice, as the sovereign has the freedom to withdraw or change its currency. But, as defined hierarchically, he had to roll up his sleeves and manage the after-effects. Patel also seems to have drawn lessons: he has set up an independent monetary policy committee, comprising three RBI officials (including himself) and three independent external members, which effectively insulates the central bank from finance ministry bullying.

Patel has so far been markedly different from his forerunners—he is neither part of the Great Indian Bureaucracy nor did his career arc reach RBI via the portals of the finance ministry; he has also visibly dialled back the central bank’s communication and outreach programme. All that remains to be seen is whether he will also write a tell-all book after his term ends at Mint Street.

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