Who Should Replace Raghuram Rajan as RBI Governor?

The media is rife with speculation about why the government refused to extend Raghuram Rajan’s tenure as Reserve Bank of India (RBI) governor. The ideas are endless: the Rashtriya Swayamsevak Sangh was unhappy with his remarks on intolerance; his policies were, to quote Subramanian Swamy, “anti-national in intent”; he orchestrated a huge campaign in the media to make the government keep him on; P. Chidambaram, and therefore, one presumes, the Congress, was still backing him. Therefore, Rajan deserved the same fate, of summary ejection, that 360 consultants to the United Progressive Alliance government suffered when the Modi government came to power.

Alongside these ideas are predictions of the harm that the Indian economy is likely to suffer from Rajan’s expulsion: foreign investment will stream out of the country because his removal will signal a return to autarchy, and therefore unpredictability, in policy-making; the rupee will depreciate dramatically and inflation will re-surface. The timing of the government’s move, only days before Britain’s Brexit referendum, has also faced criticism, because it will magnify all these effects, should Britain decide to leave the EU.

Buried in all the speculation is the possibility that the government sacked Rajan because of his stubborn refusal to lower the interest rates. But even that is being seen as a political move designed to assuage the wrath of powerful industrial and construction lobbies in the country, and not as a hugely belated response to a decade-long dear-money policy that has each year destroyed industrial growth, bankrupted the entrepreneurial class and blighted the future of six to seven million youth who would otherwise have found jobs.

The pressing priority

The truth is that Rajan should have gone earlier. He had to go because he had continued to oppose rate cuts for two years even after his own, invented justification for keeping them up – namely, the persistence of inflation – was no longer relevant. Today, the only thing that responsible media should be discussing is how to minimise the immediate fallout his departure will cause. But that, unfortunately, is the last thing on everyone’s lists.

There is no doubt that the timing of Rajan’s departure is unfortunate, but whatever turbulence follows Brexit (if it happens) will be short-lived. The main threat to the economy will stem from the uncertainty that the change of so key an official will create, especially among foreign portfolio investors. The longer the government keeps the position vacant, the worse the situation will become. Should some of the investors pull their money out, the resulting fall in share prices will trigger the herd mentality and cause further, much larger, withdrawals.

So, no matter who did what, the government’s absolute first duty is to announce a successor without any further delay. That successor has to meet several requirements:

Firstly, their professional qualifications must be stellar and beyond question. Only then will the international financial community be convinced that the government is only changing the governor and not undermining the autonomy of the RBI.

Then, they must be a first-class economist who can explain and justify his or her decision to lower interest rates with sound economic logic. This must not be seen as another victory of crony capitalism.

Finally, the transition from the regime of Rajan to that of his successor – the time they take to become familiar with subordinates at the RBI and the members of its advisory committees, as well as learn the technicalities of the bank’s working – should be as short as possible.

The best candidate

There are any number of excellent Indian economists who meet the first two qualifications. And any one of the RBI’s present deputy governors meets the third. But finding a successor who meets both the first two and the third requirements will not be easy.

There is, however, one person already associated with the Modi government who meets all three needs to the fullest extent. That person is Bimal Jalan.

Jalan is an economist by profession and has numerous books to his credit. He is perhaps the only ‘outsider’ (to the Indian Administrative Service) who has risen to become the finance secretary, an achievement that speaks volumes for his ability and tact. He was the governor of the RBI for six years, from 1997 to 2003, and is therefore well-known among, and held in high regard by, the international financial community. Most of all, it was he who, while working closely with the then finance minister Yashwant Sinha, steered the Indian state through the aid cut-off that followed the May 1998 nuclear weapons tests, and then out of the recession of 1997-2002, onto the 8 to 9% growth path, by halving bank lending rates between 2000 and 2003.

To do the former, Jalan had to attract Foreign Direct Investment from Indians living abroad, and he did so by raising interest rates at the beginning of 1999. This killed an incipient industrial recovery that had begun under the spur of huge harvests in 1997 and the sudden jump in disposable income caused by the Fifth Pay Commission awards a year later. But Jalan began to lower interest rates less than two years later as NRI money poured into the Millennium and India Resurgent Bonds that the government floated in international markets to offset the sudden cut-off of foreign aid.

By the beginning of 2003, lending rates had halved, but the share markets were reviving as promoters turned to them to raise risk-free capital for investment. It took only one spark to ignite the sharpest stock market boom India has experienced to date, and this was provided in May, 2003, by Maruti Udyog’s decision to sell 20% of its shares to the public. This sale was oversubscribed 13 times, and the gold rush began. It did not peter out till eight years later, in 2011, and then, as in 1995, it was the morbid fear of inflation in a Congress government that brought it to its end.

Rajan was a stranger to those events, as he was in the US as they unfolded. Jalan, however, was completely a part of the whole experience.