In his last public speech as the RBI Governor at St. Stephens College, New Delhi on September 3, 2016, Dr. Raghuram G. Rajan clarified why central banking was not as easy as it seemed – just raising or cutting interest rates – and why it required decisions, sometimes unpopular or hard-to-explain ones, to be made under circumstances of extreme uncertainty and argued in favour of having an independent central bank and the role and responsibilities of the central bank governor.
The central bank governor has to make difficult policy choices often in the face of uncertainties after weighing the alternatives as best as one can. He cited the example of 2013, when due to weak macro fundamentals the rupee tumbled and it was necessary to get back the confidence of international investors and how he, who had just taken over as the Governor of the Reserve Bank, had to decide on introducing the FCNR(B) scheme in the midst of uncertainties. That the decision proved to be beneficial for the country, the Reserve Bank and the banks, taught him that “Policy making invariably involves taking measured risks in the face of uncertainty.” He then made out a case for India to have a strong and independent central bank so that it could ensure macroeconomic stability.
It is for taking complex decisions – often difficult for the common citizens to understand – that the central banks should be independent and should be able to say ‘no’ to seemingly attractive proposals, he argued but added that at the same time, it also cannot become free of all constraints. “It has to work under a framework set by the Government,” he said. In his view, “Frameworks reduce the space for differences” and it was important that the constitutional authorities clearly outlined the central bank’s responsibilities.
He gave two examples – a framework for inflation objective and a risk management framework for RBI that indicated the level of equity the RBI needed, given the risks it faced, to be adopted by the RBI Board. “The RBI did not have the luxury of economic inconsistency,” he said, be it interest rates, exchange rate, pushing banks to clean up or paying dividend to the government. In a poor country like India where so many people lived at the margin, the role of the central bank was to ensure that growth did not exceed the country’s potential, adopting prudential policies that reduce the risk, and building sufficient buffers that the country was protected against shocks. The Governor also explained the economic rationale of why the RBI cannot pay special dividend to the government – in addition to the entire surplus being paid out for the last three years.
He explained that paying a special dividend over and above the surplus RBI generated, as had been suggested, was legally not possible. And even if it were legally possible, and even if the Board were convinced a higher dividend would not compromise the creditworthiness of the RBI, this not reduce overall market borrowing by the government, defeating the very purpose of special dividend! He instead made out a case for transferring to the government the entire surplus of the RBI, retaining just enough buffers that were consistent with good central bank risk management practice. “Separately, the government could infuse capital into the banks. The two decisions need not be linked,” he pointed out and further suggested that the Government should acknowledge its substantial equity position in the RBI and subtract it from its outstanding debt when it announces its net debt position. That would satisfy all concerned without monetary damage.
The Governor also argued for operational freedom of the central bank, “albeit invariably in consultation with the Finance Ministry” in matters relating to macroeconomic stability. “Multiple layers of scrutiny, especially by entities that do not have the technical understanding, will only hamper decision making,” he said and suggested that instead, the government-appointed RBI Board, which included ex-officio government officials as well as government appointees, should continue to play its key oversight role. He pointed out in this context that at present all important RBI decisions including budgets, licenses, regulation, and supervision are either approved by the Board or one of its sub-committees and it was, therefore, important to quickly fill the vacancies in the RBI Board so that the full expertise and oversight of the Board could be utilised.
In the interests of macroeconomic stability again, he argued that the Governor’s rank should be commensurate with her position as the most important technocrat in charge of economic policy in the country. On communication, Governor said that in a developing democracy such as India, the RBI Governor also has to continuously make the case for the actions the central bank is taking, including the many structural reforms that were underway. Communication was as much about educating as it was about informing – be it with entrepreneurs and retail borrowers or pensioners or Parliamentarians, he said and added that public understanding could help ease the way for reforms, as well as increase support for policies. “The RBI Governor therefore has to explain again and again…and occasionally also warn about the dangers of certain courses of action or certain tendencies in the economy for growth and macroeconomic stability.”