Raghuram Rajan, darling of Dalal Street, ‘devil’ for Delhi Durbar

Sometimes words speak louder than actions. If nowhere, then at least in India.

RBI chief Raghuram Rajan has fallen victim to his own candid words (read speeches) on issues of political import. However, his legacy doesn’t lie in his articulations as a blunt economist but as a top-class, innovative and professional central banker.

And here comes the problem for his successor.

The next RBI chief will have to meet the expectations of those for whom central banking is not political rhetoric but an institution which decides the fate of inflow-outflow of billions of dollars to and from the Indian markets.

As the government moves forward towards appointing the next RBI governor, it cannot shrug off Rajan’s legacy, which is required most now that global headwinds such as Brexit, US elections and surge in crude prices are clouding the Indian landscape.

Unlike his predecessors, Raghuram Rajan has always addressed two galleries in India. The first one - the political street - often gets perturbed by his comments. While for the second camp - Mint Street and Dalal Street - his actions as a central banker count for more than his words as a “free thinker”.

Why did Rajan become a rockstar central banker?

The answer does not lie with Delhi Durbar. One has to cut across from Delhi to reach Mumbai or maybe Tokyo, New York, London or Hong Kong to understand what Rajanomics means to the Indian monetary policy.

Surprise is a bad word for the financial markets and Rajan simply took that element out of the monetary policy. Rajan provided much needed predictability and transparency to the Indian monetary system, which we lacked despite two decades of economic reforms.

So what did Rajan do with India’s central banking that made him the darling of Mint Street and Dalal Street?

Let’s start with a quick primer on RBI’s role in the Indian economy.

RBI regulates money supply in the system to control inflation with the help of various monetary instruments including guidance on interest rates - the prime one. The RBI manages demand and supply of foreign exchange to insure a reasonable rupee/USD exchange rate suitable for exports and imports.

RBI is the government’s sole merchant banker and insures the success of the central and state government’s gigantic annual borrowing programmes. And last but not the least, RBI is the regulator of India’s banking and financial industry, thus responsible for the health of India’s massive and burgeoning financial sector.

Let’s take the rupee first, which comes as a perennial fault line to the Indian financial setting.

On June 1 this month, the rupee took a sudden and severe knock when an unconfirmed report suggested that Rajan was disinterested in a second term. The reaction was only because of the way Rajan provided predictable stability to the currency.

The rupee was at its all-time low against the dollar when Rajan took over as RBI chief in September 2013. During his three-year-long tenure, on an average the domestic currency has witnessed only 4 per cent of volatility, which is the lowest when you compare the figure with that of preceding RBI governors.

For the record, rupee has witnessed 5 and 6 per cent volatility against the US dollar under the regimes of YV Reddy and D Subbarao, respectively.

As Rajan is moving on, a likely spurt in rupee’s vulnerability is more than obvious. 

The government is yet to come up with its reforms on the banking front. However, thanks to Rajan, all public and private sector banks have been cleaning their balance sheets by setting aside provisions to provide for the bad loans they are carrying.

This was a gutsy call indeed. This has escalated pain (read losses) for banks, but will turn out to be a panacea on fighting bad loans.

The government has to insure the process does not fall in jeopardy because of Rajan’s exit.

Surprisingly, Rajan is being hounded for his best creation amid taper tantrums.

The most important change Rajan has established was to effect a quick transition from being a central bank that loosely targeted both GDP and wholesale price inflation (WPI) to one that now unambiguously focused on benchmarking consumer inflation (CPI).

Credible inflation targeting ensures risk free rate regime and reduces volatility both in the forex and equity markets. This has been apparent during era of Rajanism.

As per the data crunched by brokerage Ambit Capital, Indian financial markets registered only 34 per cent volatility during the tenure of Rajan, as compared to the 60 per cent and 240 per cent volatility under Reddy’s and Subbarao’s dispensation.

A predictable monetary regime and innovative reforms to ensure less capricious markets is Rajan's effect on India’s financial system. Markets will definitely miss Rajan when they foresee looming Brexit, rising crude oil prices and possible pressure on the rupee ensuing redemption of NRI deposits.

Institutions are always bigger than individuals but we must not forget that we haven’t got a potent Election Commission after TN Sheshan and neither has the CAG post got his sting back since Vinod Rai.

Despite that, we should not conclude that the same will happen to RBI after Rajan’s exit.