The `Fault Line' Man

Its official now. Chief Economic Advisor Raghuram Rajan will be the next Governor of the Reserve Bank of India after the current Governor D Subbarao retires in September.

Raghuram Rajan

"Prime Minister has approved the appointment of Dr. Raghuram Rajan as the Governor of Reserve Bank of India (RBI) for a term of three years, vice Dr. D. Subba Rao upon completion of his (Dr. Rao's) tenure …" the bland statement said.

However what it left unsaid was the great amount of politiciking which went on behind the scenes before 50-year-old Rajan was given the job of heading India's central bank at a time when GDP has slowed down to 5 per cent from an average of 8-9 per cent through the last decade, inflation remained high at nearly 5 per cent and the Rupee value against the dollar has come down by some 12 per cent in just over a month.

In the last few weeks, Rajan who has earlier served as chief economist with the World Bank and taught at University of Chicago's Booth School of Business, was locked in a race with Arvind Mayaram, secretary in the finance ministry for the job after Subbarao told finance minister P Chidambaram that he was not keen on another term.

Subbarao who may have said otherwise, had little choice but to move on as  signals coming out of New Delhi made it quite clear that he may not be the man the UPA Government wants at this crucial stage.

Finance Ministry insiders say that Rajan, was always the favourite for the slot, with Chidambaram himself backing him for the job. While prime minister Manmohan Singh, who himself had been an RBI Governor, too preferring giving an economist a shot at the job at this crucial juncture.

D Subbarao

The powerful Indian Administrative Service (India's civil service's upper echelon) lobby was however seen backing Mayaram for the job as it was possibly keen that the country’s top money manager’s job remained with it. Subbarao too had been an IAS officer as had been his predecessor Y.V.Reddy.

Rajan does not really have much administrative experience but is considered one of the brighter young economists having earlier forecast the coming global financial crisis in a lecture made to the world's central bankers at their annual retreat in Jackson Hole, Wyoming, USA in August 2005. Not something which the central bankers exactly appreciated at that time.

Writing later in his bestseller `Fault Lines: How Hidden Fractures Still Threaten the World Economy’, Rajan described the situation as :  "I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions."

His colleagues at North Block said that might exactly be how he might feel when he goes to run one of the most complex and powerful central banks of the world from next month on as he has at many times been arguing exactly the opposite of what the RBI has been doing, especially on cutting interest rates.

North Block and Subbarao had not seen eye to eye for quite a long time with Subbarao refusing to toe the finance ministry line that economic growth should be the top priority by arguing that inflation remained his primary concern and delaying cutting high policy interest rates or by reducing interest rates in small driblets of 0.25 per cent.

The problem, officials claimed was that Subbarao who has earlier served as finance secretary felt the finance ministry had no business telling him what to do as he knew both the jobs, while the UPA government felt the RBI Governor did not understand the political imperatives of creating new jobs and raising growth rates in a pre-election year.

While the tension between the Ministry and RBI had remained contained during President Pranab Mukherjee’s tenure as finance minister, it was in the words of one North block top honcho “quite palpable”, after Chidambaram took over.

Both the RBI and the government knew that a foreign exchange cloud was on the horizon as early as the beginning of this calendar year. Indian companies have to pay back $ 170 billion in short term debt by March-end 2014, while its forex reserves are just about $ 280 billion. However both seemed to be crossing out the others’ suggested solutions to the problem. When the government which has always been conservative over sovereign bonds thought about it, the RBI opposed it openly. The RBI on its part delayed taking steps to tighten controls over foreign exchange markets which could have reduced speculation on the rupee.

The Iconic RBI Building at New Delhi

Rajan after getting the news that he was the chosen man for the big job, said he has “no magic wand” to solve the slowdown but advocated close coordination between the government and RBI in handling the ongoing crisis which has seen the rupee slip to below Rs 61 to the dollar levels frequently and Jan-March 2013 GDP growth slipping to 4.8 per cent. This `co-ordinated' approach was something which the Government and markets wanted to hear. The Indian Rupee recovered shortly after his appointment was announced.

At least one thing is assured, say colleagues, Rajan will act. "The cost of doing nothing," the economist had written in his seminal book `Fault Lines’ on the global financial crisis and its causes, "is perhaps worse turmoil than what we have experienced recently" because "unchecked, the fault lines will only deepen."

The Story Behind New Banking Licences

Safeuarding Prudential Banking

As the Reserve Bank gets ready to announce guidelines for new banking licences within the next fortnight, the fine print in those very guidelines have become a bone of contention between the country’s central banker, charged with safeguarding prudential banking norms, and the Finance Ministry, which wants new banks to pep up the economy.

The Reserve Bank is adamant that it wants guidelines framed to keep out large corporate houses and real estate Moghuls from cornering these licences, as their business interests may clash with prudential norms needed to run banks they want to float. The finance ministry is just as adamant that rules should not keep corporate houses out, but rather rules should set up Chinese walls between owners and banking operations, so that owners can turn in profits but not subvert banking norms.

Unfortunately for North Block, the chairman of the prime minister’s economic advisory council, C.Rangarajan, a former RBI chief himself, has thrown his weight behind the central bank’s point of view.

A string of disastrous bank collapses in the 1960s, had seen the Indira Gandhi led Congress government nationalizing most large banks. There were accusations of widespread abuse of public funds by bank owners who often siphoned off monies to run risky businesses, whose failure jeopardised the entire banking and financial industry. The central banker points to this history and lack of any evidence that Indian business houses will be willing to change their ways for its unwillingness to grant bank licences to corporates.

RBI’s allergy towards real estate Moghuls like DLF being allowed to run banks stems from similar considerations, buttressed by examples of the mortgage crisis faced by American banks. The fear obviously is that realty firms allowed to own banks would use them to fund development and sale of risky realty projects, which in turn could promote a property bubble.

Finance Ministry officials argue that powers of supervision which the RBI was seeking including powers to supercede entire bank boards, if they were suspects in wholesale frauds, have been given through a banking amendment act passed by Parliament in the last Parliament session and the central bank has consequently no excuses in not agreeing to allow corporates entry into the banking sector.

One way out of the imbroglio, which is being suggested by officials trying to work out a mediation, is that the rules do not specifically prohibit large corporates from applying for licences, but preferences are built into the guidelines which would continue the current system where private banks are allowed as `graduates’ from among merchant bankers and financial firms which had grown large enough to qualify as banks.

The problem with continuation of the earlier system is that those whom the RBI granted licences last time round they were given out, included some merchant bankers who proved to be damp squibs at best and horror stories at worst – these included -- Centurion Bank and Bank of Punjab – which had to be merged and later acquired by HDFC Bank as well as scam-hit Global Trust Bank which had to be ultimately taken over by Oriental Bank of Commerce.