S Gurumurthy By

In highly dignified words, which fit his character, Raghuram Rajan has scotched all media hype and speculation and said that he would like to go back to academic work after September 4, when he retires as Governor of the Reserve Bank of India (RBI). For a couple of months the media had made huge news business out of whether the Modi government would continue with him or not. Rajan’s dignity did not calm the media. It made an issue out of his exit too. It first kept advocating he should continue. Then turned it into a prestige issue for itself. It downsized whether Rajan should continue or not into a street affair. It mindlessly advocated against what is essentially the prerogative of the government and invited counter campaign. Finally it reduced the Rajan extension issue into a street brawl between those who wanted him and those who did not, bracketing those who admired him as a person and an economist but not his policies, with those who did not. No one could have embarrassed the gentle Rajan more than his self-appointed advocates. The street brawl for and against Rajan was exported, and it echoed, abroad, particularly in US. The Wall Street Journal directly asked Prime Minister Narendra Modi on the eve of his US visit: “Do you support the reappointment of Mr Rajan?”. Modi silenced the voice of US financial actors by saying, “I don’t think this administrative subject should be an issue of interest to the media”. Now on to the Rajan exit story.

UPA discounted Rajan

P Chidambaram, who was the Finance Minister when Rajan was appointed as Governor, has expressed his acute pain at Rajan not being repeated. The Modi government does not deserve Rajan, he says. Now go back to 2013 and see how this great Rajan admirer treated him then. Under the law, the full term of an RBI Governor is five years. But the UPA appointed Rajan only for three years. That is, it gave him only a 60 per cent rating. All his predecessors post-Independence, barring only two — Dr Manmohan Singh and S Venkitaramanan — were appointed for five years. The age of six of them was 60 or close to it when they were appointed and five of them, were in their mid or late 50s. Yet all of them were appointed for the full five-year-term. But Rajan was the youngest, only 50, when he was appointed. If Chidambaram, who values Rajan so much, had got him appointed him for full five years, Rajan would have been in office till September 2018, almost co-terminus with the Modi government’s five-year-term. Most certainly the Modi government would not have sacked him midway. Did not the UPA government discount Rajan by giving him a truncated term, putting him at the mercy of the successor government?

Rajan and Reddy

Who is Rajan? A man of intellectual integrity and character, respected for his independence, Rajan differed from the mighty Wall Street in US supported by the then US Federal Reserve Chairman Alan Greenspan. Greenspan was, for two decades, worshipped as the God of Money, who could and did create money out of thin air and kept the US finance theatre going. Rajan had forewarned the US of the impending disaster of 2008. That was how he became famous in the world of finance. And that brought him to India. He was a celebrity even before he became the RBI head. The other way round in the case of his predecessor's predecessor Dr YV Reddy. Dr Reddy became a global celebrity central banker based on his stewardship of the RBI during the global crisis. Joseph Stiglitz, Nobel Laureate in economics (2001) said, “If America had a central bank chief like YV Reddy, the US economy would not have been in such a mess.” The New York Times (Dec 19, 2008) credited the tough lending standards Reddy had imposed on Indian banks for saving the Indian banking system in 2008, when cheap money was flowing into India in billions. Despite all pressures from Chidambaram, Reddy did not allow the government to live off the easy money. Chidambaram, who had shared no friendly relation with Reddy, himself confessed in 2011 that Reddy must have had a “premonition about the 2008 crisis.” Reddy prevented reckless lending by Indian banks and avoided the crisis. Rajan wrote against cheap money, Reddy acted against it — both when the whole world was celebrating cheap money. While Reddy became famous as Governor, the famous Rajan became the Governor. Understandably Rajan must have been under pressure from within to protect his celebrity profile abroad. But Reddy was in sync with Indian economy as well as the West. Rajan knew the West, but he was not in sync with India. While everyone knows about Reddy’s global fame as monetarist, most analysts do not know about his work on rural banking, on reviving co-operative banks, his focus on the common man, and his emphasis on financial inclusion through information technology. This made Rajan and Reddy, both otherwise brilliant, different. Rajan, who had spent his whole life after postgraduation in US, missed interior India like Ludhiana, Bhatala, Rajkot, Jamnagar, Baroda, Morvi or Coimbatore, Tirupur, Namakkal, Karur, Sivakasi down south where business entrepreneurship has grown as a communitarian movement, almost disconnected from the formal banking — read monetary — system. Had he done so he would have understood that Mumbai is not India and the knowledge about India is beyond its expertise. Just a couple of examples, out of several hundreds. Most policy makers in India do not know that it is Morvi in Gujarat which has the highest per capita income in India. More than half its population is employed or self-employed. It produces 70 per cent of gross national ceramic production, (5 per cent of the world’s), some 80 per cent of the country’s Compact Fluorescent Lamps (CFL) and is also the largest producer of wall clocks in India. It is the social capital of Morvi, not any IIT or IIM or university that did it for Morvi. Many do not know that two thirds of the knitwear entrepreneurs in Tirupur, which exports almost $4 billion worth garments, have ended their formal education before Class 10. In 2009, the banks under RBI supervision cheated them by illegally selling exotic derivatives and caused them losses of Rs 400 crore. They paid that money, which they did not borrow, without asking for a write off. This unorganised part of Indian economy would not figure in the financial media which is hooked to the stock market as the measuring rod of the Indian economy. This India was not on Rajan’s radar.

Mudra and Rajan

When the Modi government came it realised that it could not generate jobs unless it funded the 58 million unfunded unorganised businesses which needed a capital of Rs 12 lakh crore — of which just 4 per cent was provided by banks. The government decided on a new financial architecture, the MUDRA bank, on the lines of the National Housing Bank, to focus on them and fund them. But Rajan’s RBI stonewalled it, saying it would lead to regulatory arbitrage — meaning seeking to profit between two regimes — and systemic risk. That these 58 million units are funded by Rs 12 lakh crore in black money is not systemic risk? Is the usurious interest charged by private money lenders — at 30 to 120 per cent — not arbitrage between regulated lending and unregulated financial markets? Are these not the concern of the RBI? Rajan did not have an answer and yet he would not think of organised finance for the unorganised sector. A study by Credit Suisse, endorsed by The Economist, both driven by western impulses, had said that the best way to organise the unorganised Indian economy, which generates half of India’s GDP and 90 per cent of non-farming jobs, is to provide it organised finance. Yet the RBI just turned its back on MUDRA, which is one of the flagship programmes of the government. The result? MUDRA is in limbo.

Fiscal vs monetary

The RBI has exclusive domain over monetary economics. But it is not clear whether it has fully grasped the impact and effect of the crash of credit growth as a percentage of the GDP from 2009-10. The ratio of bank credit to GDP had slipped from 10.95 per cent in 2009-10 to just 4.4 per cent in 2015-16. In the same period the fiscal deficit too was cut from 6.45 per cent to 4 per cent. The combined fiscal deficit and bank credit fell from 17.4 per cent to 8.4 per cent — to less than the nominal GDP of 11 per cent for 2015-16. When there is a secular fall in bank credit, the only way the government could fix the economy was by expanding the fiscal economy — read by raising the fiscal deficit. But Rajan who, in trying to target bad loans, virtually destroyed the business appetite for credit, would not even allow government the flexibility of a higher fiscal deficit to energise the economy. He began saying, and the Western media began quoting, that he was watching whether the government moved towards fiscal consolidation — meaning towards the fiscal deficit target of 3 per cent — or not, a domain that was not his. His monetary fundamentalism came close to Western textbook rules whose universal validity has become suspect even in the West, with each country working out its own independent course. With the result, the economy becoming increasingly starved of money, the government was forced to seek to to amend the law relating to fiscal deficit for a new fiscal-monetary relation so that if one goes up the other comes down. With the credit offtake falling in a rising economy, the RBI ought to be clearly seeing where the vitamin of money comes from to finance the higher growth. The new finance is sourced in an unprecedented rise in cash holdings which have risen to Rs 15 lakh crore in 2015-16 with the share of high denomination notes in the total currency in circulation rising from 33 per cent to 85 per cent in 2015-16. These distortions were occurring under the very nose of Rajan. But he overlooked them, because he had never handled economies where banks do not control the entire monetary system.

QED: Change of guard at the RBI is inevitable. India does not need a celebrity governor. It needs an economist who knows the hinterland India, who can keep his head down and work. To U-turn the current direction of the RBI will take a long time — but let it begin at least.

S Gurumurthy is a well-known commentator on economic and political affairs

Email: guru@gurumurthy.net