Outgoing RBI Govenor D Subbarao
"The Chinese have a saying, may you live in interesting times," Duvvuri Subbarao had said in June 2009, when he was hardly nine months into his new job as the Reserve Bank of India's (RBI) 22nd Governor. Set to complete his five year term and retire on September 4, he recalled his comment recently at a financial management summit organised by a leading economic daily in Mumbai. "I can hardly complain," he said, amid loud laughter from the audience of pin striped bankers listening keenly to him. "These have been interesting times for me, perhaps a bit too interesting."
Barely a fortnight after Subbarao took over in September 2008, US based investment banker Lehman Brothers went belly up triggering a global economic downturn. Subbarao, a 1972 IAS officer from the Andhra Pradesh cadre, had to cope with its fallout in India. He was no novice though. He may have studied Physics at the prestigious Indian Institute of Technology, Kanpur, but since then had worked extensively in the finance ministry as well as the World Bank for two decades before joining the RBI. Subbarao was handpicked for the position of RBI governor by none other than current Finance Minister P. Chidambaram himself, during his earlier stint in the same position in 2004-2008.
Many may have thought Subbarao would behave like a finance ministry lackey in the central bank. He proved them completely wrong. Far away from New Delhi, at the RBI headquarters on Shahid Bhagat Singh Road, Mumbai, Subbarao knew he had his work cut out for him - ensure financial stability, keep inflation under check and support growth in the economy. One more thing bothered him, as he informed Business Today shortly after taking over - the lack of fresh air in his 18th floor corner room. The last he could do little about.
Subbarao knew well he was occupying a chair luminaries before him had done - among them, M. Narasimham, I.G. Patel, C,D. Deshmukh, current prime minister Manmohan Singh, R.N. Malhotra, C. Rangarajan, Bimal Jalan and Y.V. Reddy. Reddy, his immediate predecessor, who was in charge at a time of nine per cent plus GDP growth, won belated respect - after the downturn struck - for having kept tight regulatory control during the gung-ho period, which left the economy better equipped to face the crisis. Before him Jalan too had effectively shielded the Indian economy from the Asian financial crisis of 1997/98.
The 2008 crisis - which has even been compared to the great depression of 1929 - started as a sub-prime crisis in the US mortgage market, but then gradually spread to Europe and other markets, India among them. At first, many dismissed the slowdown murmurs, noting that the Indian economy was still buoyant, but not Subbarao. His immediate concern was to ensure financial stability.
Indeed, the banking system seemed more vulnerable than the economy. ICICI Bank, the biggest private sector bank, for instance, was in the news for all the wrong reasons - possible exposure in the sub-prime market and mark to market losses in other banks.
The post crisis period exposed the chinks in central banks across the world. They had been behind the curve when it came to gauging the implications of innovative or exotic financial products in the market. It was said that Indian banking remained unscathed because Subbarao's predecessor Reddy had implemented the right policies. But Subbarao was not entirely certain. He felt the Indian banking model, especially that of banks with dozens of subsidiaries in capital intensive life insurance or capital market related businesses, was dangerous to financial stability. What if one of them failed? He was not at all comfortable with the universal banking model. "It may work in some countries and situations, but not in others," he said.
His next big challenge arose when he had to nudge Indian banks, which were struggling to implement the Basel-II framework, towards gearing themselves up for the still more stringent Basel III regulations. And this required higher capital provisions for financial risks.
Following the global recession, Subbarao realised quickly that the Indian economy was not immune. Manufacturing growth was slowing down, inflation was in the double digits and stock markets were falling. Many Indian corporations which had made billion dollar acquisitions abroad were over-leveraged. The domestic currency was witnessing a flight of capital, especially by foreign institutional investors (FIIs). The rupee, after appreciating to 39 to the US dollar in 2007/08 had started to fall, hitting the 45-46 range in 2009. There was a danger of growth slowing down.
To stimulate growth, Subbarao, in his first seven months as RBI chief, reduced the repo rate (the rate at which the RBI lends to banks and which in turn determines lending rates) from nine per cent in September 2008 to five per cent in March 2009. By then, it was clear that the Indian economy would be settling at a much lower 6.7 per cent GDP growth rate in 2008/09 against 9.1 per cent in 2007/08. Was he wrong in reducing interest rates when inflation was inching up? Some bankers feel he was.
Subbarao's first big mistake, according to them, was reducing interest rates in 2008/09. The wholesale price index (WPI) recorded an average increase of 8.2 per cent that year, much higher than 4.7 per cent in 2007/08.
While India was slowing down, global central bankers and governments were taking measures to avoid a recession. Soon a danger arose, which initially went unnoticed. The US Fed started to buy bonds by pumping money into the US financial system. Quantitative easing (QE), as this was called, reached about $ 85 billion per month. A part of this new found liquidity flowed into the equity and bond markets of emerging economies like India. Traces of QE money were visible in the country's stock market, where FIIs, which had been withdrawing, began pumping in money instead.
For example, FIIs investment in Indian equities in the first six months of 2009/10 was $14 billion, as against an outflow of a little over $5 billion in the same period the previous year. Dollar inflows into the country also boosted the Indian rupee value against the US dollar. The rupee's slide was halted and it remained in the 45 to 48 a dollar range through 2009/10. There was no threat to growth as advanced estimates showed growth of over eight per cent. Subbarao kept interest rates benign -- the repo rate was 4.75 per cent for the most part of 2009/10.
Subbarao also took a path-breaking step in November 2009 when he decided to buy 200 tonnes of gold from the International Monetary Fund for $6.7 billion. He wanted to diversify the country's foreign exchange assets. Though the gold component of forex reserves is minuscule (less than five per cent) this move was appreciated by the market. GDP growth for 2008/09 was 8.6 per cent.
But then, around September 2010, inflation started growing. Inflationary pressure was the result of low interest rates, global money and supply side issues in India which got compounded because of a poor monsoon. By the end of 2009, the challenge for Subbarao was to tame inflation. So he now began to raise interest rates, just the opposite of what he had been doing earlier. At a seminar in October 2009, Subbarao explicitly stated that India's policy rates would have to be tightened, ahead of those in advanced economies. "The resultant larger interest differential (domestic and global) may attract larger capital inflows," he said.
In March 2010, Subbarao for the first time hiked the repo rate by 25 basis points to five per cent. Just two months before that, in January, Pranab Mukherjee took over as the finance minister. Growth prospects remained bullish in 2010/11 because of global liquidity and low interest rates.
Subbarao's 2009/10 patch remains controversial. He was accused of not building up foreign exchange reserves when the rupee kept appreciating due to the dollar inflows following the QE, by, among others, Arvind Panagariya, Professor of Economics, Columbia University. Panagariya even called Subbarao's tenure one of the worst performances by an RBI governor.
But Subbarao has addressed the criticism. At a May 2010 global meet, he said it was important to distinguish between countries whose reserves were a consequence of current account surpluses (like China) and others with current account deficits (like India) whose reserves were purely a result of capital inflows. "Our reserves comprise essentially borrowed resources, and we are therefore more vulnerable," he said. In addition, the decision to buy dollars to accumulate reserves would have required the permission of his political masters.
To stem inflation, between April 2010 to March 2011 , Subbarao hiked the repo rate from 4.75 per cent to 6.75 per cent. This was when his differences with the finance ministry began to surface. The governor was correct in targeting inflation as average inflation (or the WPI) was 9.6 per cent in 2010/11. But the country saw a GDP growth of 9.3 per cent that year - the highest since 2008/09.
While the growth story looked intact, rising inflation and interest rates were a big concern. There was no dearth of advice for Subbarao - from ex-RBI governor C Rangarajan and now Chairman of the Prime Minister's advisory council, to Montek Singh Alhuwalia, Deputy Chairman of the Planning Commission to Kaushik Basu, now Chief Economist at the World Bank, all chipped in.
Even though inflation in 2011/12 moderated at 8.9 per cent, Subbarao kept raising the repo rate from 6.75 per cent in March 2011 to 8.50 per cent in March 2012. Some in the banking industry say that this was unwarranted.
Prime Minister Manmohan Singh supported Subbarao strongly for the first three years of his tenure. But things were not going well for Subbarao with the finance minister. Mukherjee unilaterally declared that new banking licences would be issued. (The RBI is the licensing authority.) Subbarao had taken the stand earlier that there was no need for more banks.
Despite this Subbarao's tenure was extended by another two years in September 2011. This extension was announced by none other than the prime minister himself. The first year of the extended stint was dominated by still more interest rate hikes in order to tame inflation. Industry and business leaders criticised Subbarao saying growth and investment would suffer. GDP growth eventually fell to its lowest in a decade touching 6.2 per cent in 2011/12. But Subbarao maintained the needs of the so-called 'silent constituency', the poor and downtrodden, who are the most affected by inflation, had to be addressed. "Inflation is a regressive tax on the poor," he said.
He also cited historical evidence to show that in the medium term, price stability and growth were not at odds. But he admitted that growth had to be sacrificed to some extent in the short term. He maintained that low and stable inflation, in the range of four to six per cent eventually helps growth in the long term.
The year 2011/12 was also the one when the current account deficit began growing alarmingly because of the rising trade deficit. It jumped from 2.7 per cent in 2010/11 to 4.2 per cent. Subbarao finally changed tack and began reducing the repo rate from April 2012, with an initial cut from 8.50 per cent to eight per cent. He further reduced it to 7.25 per cent in subsequent months.
But critics continued to carp that the pace of reduction was very slow. Subbarao responded by pointing out that he had to be cautious since the government had not provided any credible roadmap towards fiscal consolidation. P Chidambaram, who returned to the finance ministry after Mukherjee was elevated to president, did come out with one in October 2012 , but Subbarao's stance did not change. Frustrated, Chidambaram famously remarked, "If the government has to walk the path of growth alone, it is prepared to do so."
Subbarao continued to insist that the country had to sacrifice some short term growth to contain inflation. GDP growth plunged still lower, to five per cent in 2012/13.
The last six months have been very stressful for Subbarao as the rupee went crashing down from 55 to the US dollar to 68. In a debate in the Rajya Sabha on the state of the economy last month , Chidambaram again noted that the RBI needed to focus on growth and employment. At the launch of a book on the RBI, Prime Minister Manmohan Singh too called for fresh thinking on monetary policy in a globalised environment.
In his last speech as RBI governor, delivering the Nani Palkhivala memorial lecture in Mumbai, Subbarao hit back at his critics. He squarely blamed the government for the rupee's fall, defended his decision to raise rates to contain inflation, and hoped that Chidambaram, who made him RBI governor, would one day realise the worth of the actions he took in that position.
Subbarao, 64, departs at a time when growth projections for 2013/14 have fallen below five per cent. In the first quarter (April-June), GDP growth was already 4.4 per cent. India is undoubtedly passing through one of its worst phases. No doubt the government is responsible for its tardy approach to reforms, but Subbarao has to share the blame.
How will the history judge Subbarao? As a governor who fought fiercely for the central bank's independence, one who had a mind of his own and honestly did what he thought was right for the economy? Or will the verdict be less favourable?