How Will RBI Governor Raghuram Rajan Build An Equation With The New Finance Minister If NDA Comes To Power

With indications that NDA may come to power, there is speculation over conflict between the central bank governor and the new govt. But much will depend on the equation Rajan can build with the new FM, the way some of his predecessors did.

The Reserve Bank of India Governor, Raghuram Rajan, passed the banking licence litmus test by leaning on Bimal Jalan. The former Chicago University Professor can take a leaf out of the same elder statesman of Indian bureaucracy on how to navigate the rough seas after May.

Soon after the Atal Bihari Vajpayee-led National Democratic Alliance, or NDA, Government came to power in May 1998, Jalan, the then RBI governor, reached out first to finance minister Yashwant Sinha and principal secretary to the prime minister, Brajesh Mishra.

That was not to save his job, but to save the economy. So convincing was Jalan that not only did he manage to end the cacophony of voices from the party that called for a stronger rupee, he also got rewarded with another term at the RBI, and a nomination to the Rajya Sabha.

Sorting out such politically tricky issues is inevitable for any central bank governor globally. At that time, it didn’t matter to the alliance that Jalan had been appointed by the previous United Front Government led by IK Gujral with P Chidambaram as Finance Minister.

Similar challenges await Raghuram Rajan, with a new government set to assume office — one which is widely perceived to be a non-Congress political formation. Doom sayers, among them, shockingly, government officials, are already at work claiming how his approach may not be in consonance with a Modi-led sarkar. In other words, count on a confrontation soon, is what they appear to be implying.

  They may well be wrong. In the last 25 years, the working relationship between the government represented by the finance minister and RBI governors may not have always been smooth. Yet, despite frosty ties, especially towards the fag end of the tenures of at least more than one governor, the political establishment has held back perhaps mindful of the downside to cutting the institution and its head to size.

Former finance minister, Yashwant Sinha is one of those who is quick to dismiss such speculation. A new government should not rock the boat and change the head of the central bank, he says, making it clear that he reckons Rajan is doing well and would distinguish himself further.

Sinha should know. For back in 1990, as the finance minister of the short -lived Chandrasekhar Government, which survived on a “daily wage basis” as ministers themselves dubbed it, he had the unpleasant task of telling the then governor of RBI, RN Malhotra to step down and pave way for S Venkitaramanan, a civil service colleague and a former finance secretary. This was after Malhotra had been given a fresh term by the previous VP Singh-led National Front Government after he completed five years.

Yashwant Sinha says that was a political decision, taken under pressure from the Congress led by Rajiv Gandhi, which provided support to the Chandrasekhar Government only to pull the plug after barely four months. The only other case of a change in guard following a new government coming to power was when KR Puri, who was appointed as RBI governor during the emergency, was moved out days after the Janata Party came to power. In RBI’s long history, there have been enough instances of governors quitting — the first being as early as 1936 when Sir Osborne Smith quit after differences with the head of the treasury and one of his deputy governors; later Sir Benegal Rama Rau quit over differences with finance minister TT Krishnamachari. Not that all this is unique to India. Such instances abound in Thailand, Argentina and a few other countries.

According to Sinha, what makes the difference is the personal equation between the two —the finance minister and the governor. It all boils down to the kind of rapport the two develop and their personalities, he says, citing his experience with Jalan when their engagement went beyond the realm of just monetary policy.

  Between 1998 and 2002, during budget making, Sinha used to lean on Governor Jalan, a former chief economic advisor, banking secretary and finance secretary, for advice on budgetary issues. That was way beyond the central bank chief ’s remit, Sinha says making the point such institutional arrangements cannot be formalised as part of statutes. What could also have helped boost such ties is the long stint in government and experience of policy making for both Jalan and his successor Reddy.

That will be a test for Rajan who soon after his appointment as governor worked out a unique, but a non-formal, agreement with finance minister P Chidambaram under which the turf was clearly marked out for both the finance ministry and the RBI. The minister who often advocated lowering rates ahead of a monetary policy review, attracting criticism for putting pressure on the central bank, worked out the arrangement with Rajan after ties between North Block and the RBI soured towards the end of Subbarao’s tenure in 2013.

That may have worked well especially with the UPA government on its last leg. But unlike some of his predecessors who had the advantage of having worked in the government for long and engaging with politicians of all hues, Rajan may have to build such ties from scratch.

That is because he has been away for long with his formal association with the government having started as late as 2008 as an advisor to the prime minister. In the second half of 2012, the former chief economist of IMF finally came on board as chief economic advisor before being appointed as RBI governor last September.

Any perceived discomfort at what lies ahead could also be because of lingering statements such as the one by BJP’s treasurer Piyush Goyal, who had indicated that the governor’s approach to inflation management was faulty.

The BJP is also uncomfortable with the idea of granting banking licences to business houses. All these come at a time when the RBI led by Rajan has pitched for inflation targeting, an approach, which a new political formation has to buy into. And which would call for an explicit agreement with the government that may be wary given the political risks in the event of any failure to cool prices. There are other major challenges, too, such as the potential re-shaping of the role of the RBI, as outlined by the Financial Sector Legislative Reforms Commission, if at all the new government chooses to pursue the recommendations, besides the future of state-owned banks.

But he cannot baulk. Rather, he will have to continue like his predecessors and lay bare unpleasant facts to the government. Manmohan Singh, who was governor between 1982 and early 1985, had to write to the finance minister in the context of high inflation that the monetary implications of a vast fiscal imbalance were truly disturbing. Similarily, RN Malhotra wrote a series of letters towards the fag end of the Congress-led government in 1988-89 and to the VP Singh government on the dangers of a severe balance of payment crisis in the offing, well before it unfolded in 1990-91.

So did Subbarao on fiscal excesses and the need for a credible fiscal consolidation. And such professional conflicts, which sometimes spill over into ego issues, are part of the job. YV Reddy, too, had run-ins with the government, including on the use of foreign exchange reserves, participatory notes or the product used by foreign portfolio investors to invest in Indian stocks and on consolidation of Indian banks.

Some in the financial markets may be busy speculating on his future. But politicians and policy makers are aware that though the current incumbent may not have dirtied his hands in the Indian establishment, he is no pushover.

Having impressed by stabilising a wobbly currency and setting the agenda in international forums, there is nothing to lose for Rajan, but there’s quite a bit for the government.