The former RBI Governor Duvvuri Subbarao's book - Who moved my interest rate?: Leading the Reserve Bank of India through five turbulent years - throws open the frosty relationship between the Reserve Bank and the government. In his book, he has revealed that how he resisted all the moves of his political masters to push softer interest rates when the inflation was high. Undoubtedly, Subbarao's tenure was a difficult one as global financial meltdown created new challenges for the monetary as well as fiscal policy. The 22nd Governor of the Reserve Bank, who is currently a visiting faculty at National University of Singapore, was in Mumbai this week to promote his book. In a chat with BT's Anand Adhikari, former governor says some of the friction between the RBI and the government is inherent and will continue despite having an institutional framework like MPC (Monetary Policy Committee). Excerpts from an interview.
Q. You have mentioned in your book that former RBI Governor Y.V. Reddy once told you that it had been a standard convention for the government to consult the outgoing governor on the choice of his successor. Was that convention followed when you retired and Raghuram Rajan was appointed?
A. No, the government did not consult me.
Q. Should there be more transparency in the appointment of a RBI governor?
A. I don't know what do you mean by transparency. Of course, the decision has to be made by the Prime Minister and Finance Minister, but it should be a fair and apolitical process. Every candidate who meets the criterion should get an equal opportunity to be considered.
Q. Should there be an institutional framework to appoint a Governor?
A. It depends. It's not necessary that institutional framework throws up a better candidate or the lack of an institutional framework always doesn't give a good candidates. Ultimately, it is the judgment of the PM and FM. But, what I am not comfortable with is the bureaucratisation of the process. It is ok if the process is open and it would even be appropriate for the PM or FM to set up a search committee to shortlist candidates and take a call based on that. But having a rigid bureaucratic process, especially for the governor of the RBI, who is more than just a regulator, is inappropriate in my view.
Q. Is there any good global practices that we can borrow for selecting governors ?
A. Not really. I think different countries follow different processes. I read the US Fed Chairman Ben Barnanke book - 'The Courage To Act' - where he has written about how there were speculation about his successors from Larry Summers to Janet Yellen . We also saw that there was a lot of politicisation of the process in the US also. We also saw how the appointment of Mark Carney as the Governor of Bank of England unfolded. So it's not a completely open process anywhere in the world. It is not as if applications are called for. It cannot be a process like that.
Q. You have mentioned in your book that you thought there were others governor contenders who fitted the bill better and your past experience was mostly on the fiscal side - not the main focus of central banking. Should there be a set qualification for a governor?
A. I don't think so. I believed and continue to believe that an intelligent man, who has got broad domain knowledge even if he not necessarily a macro economist, can do the governor job provided he is intelligent enough to absorb all the advise that he gets and reach a judgment. Take for example, Christine Lagarde, the MD of IMF, is not an economist. She is doing a great job at the IMF. I think to prescribe qualification for the job of governor is over constraining the problem.
Q. Given the global monetary policies impacting the emerging economies like India and talks of domain expertise and specialisation, don't you think a governor should have a set qualification?
A. Not necessarily. The RBI as an institution has depth and breadth of expertise and competence. It is sufficient if governor has leadership qualities. He should be intelligent, able to absorb all advise and wise enough to distill that advise and reach a decision. That should be sufficient because the ideas relating to domain come from the staff of the Reserve Bank.
Q. The discussion for formation of a MPC first came up in your interview meeting with FM in 2008. Did RBI or the board discuss the modalities of a MPC framework during your five-year tenure?
A. The MPC issue was not discussed at the board. This was an idea, which was generated, discussed and developed outside of the board of the Reserve Bank. It was something both the government and the RBI was thinking about. I talked about it during my interview meeting with the then Finance Minister P. Chidambaram and subsequently mentioned it at couple of speeches including Nani Palkhivala Memorial lecture where I referred the need of having a MPC in India. There were different views on what should be the constitution of MPC, what should be the role of the Governor within the committee and whether he should have the veto or casting vote. But on the broad policy of having a MPC, there was by and large a consensus.
Q. Does formation of a MPC now will reduce the long-standing friction between RBI and the government?
A. It is not necessarily the case because some of the friction between the RBI and the government is inherent. RBI tends to take a long-term view to maintain price stability which is a necessary condition for growth whereas government typically have a shorter-term horizon because they have to show results for the purposes of electoral politics. Therefore, there is some tension between the central banks and government everywhere. Having a MPC need not necessarily reduce the friction. It depends on how the institution of MPC gets established. If there is healthy convention, healthy protocol and healthy practices of the MPC reaching at an independent decision, then the friction between the government on one side and MPC and RBI on the other side will continue. If on the other hand, the members of the MPC, appointed by the government, continue to show their allegiance to the government and canvass the government's point of view compromising their own judgment, it will undermine MPC.
Q. But, is there possibility of government members in the MPC canvassing the government point of view?
A. That is certainly a possibility, that is why establishing the institutional mechanism of the MPC on very healthy lines right from the beginning is very important.
Q. The Financial Sector Legislative Reforms Commission (FSLRC) recommended seven members in the MPC whereas RBI's own committee headed by Urjit Patel suggested a five-member MPC. The government and the RBI have finally agreed on a six-member MPC. Are you comfortable with the three-plus-three composition?
A. My comfort is irrelevant as I'm no longer a governor. I think three-plus-three is fine with a governor having a casting vote or a second vote. But, I would have preferred that in the transition period from governor as an individual making the decision to MPC committee making a decision if he had a transition time where the MPC would be there but the Governor has a veto. I thought that would have given us time to transit from one model to another. But the government decided otherwise.
Q. But there is also a possibility of government influencing the deputy governor in the MPC as the appointment is done by the government. You have written in your book how the government didn't agree to your recommendations of reappointing two deputy governors.
A. To the extent they can influence the governor, they can influence the other deputy governors. Both the governor and deputy governors are appointed by the government. But the expectations and experience has been that governor and deputy governor have acted independently. They listen to the government but act independently.
Q. Should RBI governor has a larger say in the appointment or reappointment of a Deputy Governor as he is also a crucial member of the MPC ?
A. I'm not asking for a change in law. Under the law, the governor and DGs are appointed by Parliament. I think there is no problem. But how that's implemented is the issue. In the implementation of the legal provision, the recommendations of the governor must be given priority. If there is an incumbent deputy governor, and the governor recommends that he or she should be reappointed subject to eligibility criterion and subject to the rules, the government should defer its recommendation of the deputy governor.
Q. You have written that RBI's inflation targeting framework is yet to be tested. Tell us what are the challenges in inflation targeting?
A. There will be challenges because bringing down inflation from 8 per cent-plus level to 5-5.5 per cent is a big challenge. But, bringing it down from 5.5 to 4 per cent is going to be much bigger challenge especially in an economy like ours where inflation is driven more often by the supply side pressures. In an economy like ours, where a majority of people are at subsistence level of income, if any improvement in income happens it is quickly translates into demand and put pressure on inflation. Under those circumstances , reducing inflation from 5.5 per cent to 4 per cent is going to be a considerable challenge.
Q. There is also an accountability factor under MPC. Does RBI has the right forecasting models or the data sources to rightly project an inflation scenario?
A. I think we can improve the mechanisms for accountability. There are some instrumentalities and practices today through which the RBI and governor render accountability. Take for example, FM answer questions on RBI, on information provided by the RBI in Parliament. To that extent, there is an indirect accountability to Parliament. Governor also appears before the parliament committee. Governor holds frequent press conferences, which is something which we do more often than the advanced economies. Overtime , we have instituted practices of town hall meetings and interest group meetings. We have started feedback mechanism. But many of these are voluntary. An institutional practice rendering an accountability will be good and strengthen the democracy. One way of doing that will be like what happens in the US or in the UK where the governor appears before the select committee of Parliament and give evidences. It is better in public, if necessary in private, but gives evidences to the committee of parliament so that the committee of parliament holds the governor accountable for the performance of the central bank. It not only creates a formalised mechanism for accountability, but also shields the governor from interference and intervention from political institution.
Q. Unlike previous governors, Raghuram Rajan often spoke on larger economic and policy issues, which was not much appreciated by the government. You have supported RBI by saying that there shouldn't be any code of conduct against speaking. Don't you think this could be another potential area of conflict between the RBI governor and the government in future?
I really don't know because we have to wait to hear either from Dr Rajan or somebody from the government about what really happened that caused Rajan not to seek reappointment. I do not know whether this was one of the factors. But, I do want to say that it should be open to the governor to speak on issues beyond the narrow domain of central banking depending on the canvass , depending on the context, on the expertise and experience of the governor. The governor should use his discretion in deciding on what topic to address and the people who criticise or the critics should also exercise discretion in evaluating in what context the governor has spoken.
Q. Do you think our polity is matured enough to appreciate constructive criticism of a policy coming from the RBI governor publically ?
A. I think so.
Q. As a RBI governor, you have commented on the significantly skewed size of Indian banks. You said the second largest bank in the system is almost one-third the size of the biggest. The government is now pushing for consolidation of banks. Your comments?
A. These merger and acquisitions are something that happen in a dynamic market. To the extent they are happening organically in response to market forces is something that we should encourage. As we know 70 per cent of the banks are owned by the government, there are also some reports I have seen that government trying to organise marriages which would be inorganic. I believe that the motivation for the government to do so is to augment capital requirement and to some extent it is capital efficiency. It's also a way of protecting smaller banks from competition with large private banks. So the government has its own incentives for encouraging consolidation. I think to the extent government matches the marriages is all right provided there is no clash of cultures, no clash of institutional practices, no clash of unions and no clash of technology.
Q. There is also a new approach to achieve financial inclusion. How do you see these new banking models ?
A. I think it's a good thing. India is a large or diverse country for several experiments to go on. Our banking space is large enough. The financial exclusion is so deep that we need new type of players. The experience has shown that large commercial banks are inefficient in covering the last mile. So these new institutions hopefully will cover the last mile more efficiently than the commercial banks.
Q. You were the first governor to talk about making the RBI a knowledge institution. Is RBI not a knowledge institution?
A. RBI is certainly a knowledge institution. I can very confidently say that the expertise and competence in the RBI is deep and broad and amongst the best in the world. But then knowledge is growing so rapidly that you cannot sit back and relax. You have to be constantly learning. The world is changing. India is opening up. The more you open up, the more vulnerable you become to global developments and you have less control on the global development. On the other hand, you have to react in a mature way and intelligently. So this requires an understanding of the dynamics of globalisation, maturity of judgment and lateral thinking. The central banking is itself changing in terms of inflation targeting, financial stability, unconventional policies etc. So, RBI has to be on top of all these new developments in order to make regulatory and monetary policies for India.
Q. Do you see any big risks in the Indian economy?
A. The external side is certainly less uncertain than it was five years ago or three years ago. We had the Brexit. It is going to have a simmering impact and not so much through the financial market but through lack of economic resurgence. But, there are much fewer unknowns today than three or five years ago. The Federal Reserve policy is quite well known. They have started lifting the rates and they will continue on that trajectory. Chinese exchange rate was under pressure but now they are assuring the world that they will let the exchange rate run on market lines. Europe and Japan are having recessionary trends and deflation. Both the central banks are in negative territory. But I don't see any blow up happening like the Lehman Brothers crisis or the deep fiscal crisis.