Until 18 June 2016, the majority of even the most aware Indians had not heard of Raghuram Rajan or the Reserve Bank of India (RBI) or its governors. Then suddenly all three became topics of heated discussion everywhere because a BJP MP, Subramanian Swamy, asked that Rajan’s term of three years not be extended.
Suddenly, the RBI and Rajan became hot topics of discussion in which everyone took sides, often without being aware of what the issues were. What had been till then an area of intellectual and policy discourse, restricted to a few economists and policymakers, became a free-for-all in which even film actors took part. It can happen only in India!
Since not many knew much about the RBI or its governors, the fact that this was not the first time that a governor was at cross-purposes with the government went largely unmentioned. The truth, alas, is different. Since 1935, when the RBI was set up, four governors have been sent packing by the government. Rajan is the distinguished fifth.
Thanks to Rajan’s looks, the debate has, perhaps, largely been personality oriented. It was not about the RBI as an institution, nor about what it does; it was not about the role that its head—referred to as governor, in a genuflection to a quaint British tradition—plays. It was not about monetary policy, which he has to conduct. It wasn’t about any of these things but about everything else.
The trigger was a letter written by Subramanian Swamy to the prime minister stating Rajan was unfit for the job. Swamy demanded that Rajan be replaced. This incensed the non-supporters of the BJP. Social media became very antisocial in Rajan’s defence. Newspaper editors growled, barked and wrote ponderous editorials.
A person, who is otherwise not given to hyperbole, said hundreds of billions of dollars would flow out of India and a major economic crisis would ensue if Rajan was not allowed to stay on as governor. Another called this the NDA’s “Vodafone moment,” suggesting that India would become a pariah in the world of global finance. Indeed, one commentator even predicted a total economic collapse. Narayana Murthy, the chairman of Infosys, said Rajan should be given two more terms.
This, too, can happen only in India.
So who is Rajan? In a nutshell, he is a highly respected academic economist who has an engineering degree from IIT, Delhi and a PhD in economics from MIT, United States. He has been a non-resident Indian since the age of 24. A tenured professor at the Chicago Business School, he has been head of the IMF’s research department. Author of some good books, he predicted the global financial crisis in one of his works but didn’t say when it would happen, so no one took him seriously.
Above all, he had an unusual attribute as far as RBI governors are concerned: he is very good looking.
Since September 2013, he has been in charge of the RBI as its twenty-third governor. Like his predecessors, he was given a three-year term, the last date of which was 4 September 2016. He would have liked to stay on for a few more years to finish what he started, but the government had other ideas.
About a fortnight into the controversy, he announced that he was going back to teaching and research. And thus ended that story with a whimper.
The heavens did not fall.
Governor No. 1: Forced to Quit
All governors, since the first one, have confused the independence of monetary policy with the independence of their post. They assume that only they can conduct monetary policy and that the government has no say in it. It might be a good idea, therefore—when they sign the register taking over as governor—to remind them of Montagu Norman’s view. The governor of the Bank of England from 1920 to 1944, Norman was powerful enough to bring down governments. According to him, the RBI had to be like a wife in a Hindu joint family who advises but does exactly as she is told. He also believed that the relationship between the RBI and the Bank of England should be that of a “Hindoo marriage,” wherein the former was the dominant spouse and the latter, the subservient wife.
His advice went unheeded. No sooner had the RBI come into being than the conflict between the governor and the government began. Sir Osborne Smith had been used to having his way as the managing director of the Imperial Bank of India, which in 1956 became the State Bank of India. He refused to do as bidden by Delhi. Sir John Grigg, who was the equivalent of the present-day finance minister, had a simpler formula for judging a governor’s attitude: where he stood on the exchange rate and the tariff rate. Sir Osborne was implacably opposed to the exchange rate of one shilling four pence as he was convinced it would be deflationary. He also wanted a lower bank rate. The government would not budge on the former and was scornful of the latter.
Sir Osborne could be outspoken when not required. From the very start of his chairmanship of the Imperial Bank in 1928, he had been at sixes and sevens with government policy. In fact, once after receiving some instructions from the secretary of state in 1930, he had complained that “anyone would assume that the Imperial (Bank) was a department and a very inconspicuous department of the government.”
In a fit of anger, Sir Osborne had also once told the government that “as long as I run the Imperial Bank, I will not be run by London or anywhere else, … I would not tolerate interference with my business.” In 1936, he had written in a letter that he was “sick to death” of the government’s attempt to “dominate the RBI.”
But it was not only over the interest and exchange rates that Grigg and Osborne fought. There were two other issues. When Osborne opposed the gold drain from India and wanted to impose an export tax on gold, the government opposed him tooth and nail. Then, when Osborne wanted to appoint A.D. Shroff, an ICS officer, as deputy governor, Grigg dismissed the suggestion calling Shroff “a perfectly frightful man and intimate crony” of Sir Osborne.
Overall, the British officers in India regarded him as a colonial who sympathized with the natives. All that could have still been ironed over, but when he called Viceroy Lord Linlithgow “a weak ass,” it was the last straw. He had to go.
So in July 1937, just two years after taking over as the first governor, he was forced to resign. Ironically, he had been appointed instead of some ICS officer or British banker, precisely to give the impression that the RBI was independent.
The British civil servants’ view of Osborne was coloured also by the fact that he was praised by Indian businessmen. The Indian Merchants’ Chamber wrote a very critical letter to Grigg after he resigned. And just as is happening now, the Congress demanded full disclosure.
The government simply remained silent hoping that the controversy would die down, which of course it did. But the episode left a very bad aftertaste, which has persisted till today, because nobody really knows what happened. As the late S. S. Tarapore, one of the greatest central bankers India has produced, had demanded, “The RBI owes it to posterity to release a dedicated volume on the Osborne Smith episode—warts and all.” It may show that nothing has changed. As now, then, too, the government wanted a subservient governor.
Decimation: KR Puri’s Rise and Fall
Just how far control had moved from the RBI to the government came home to the RBI in 1975. The governor was a mild ICS officer called S. Jagannathan who had managed to keep things on an even keel since 1970. But early in 1975, when political power in Delhi had become centred on Indira Gandhi’s son Sanjay, Jagannathan got a rude shock. Sanjay, who started a car factory called Maruti, wanted the credit limit for his company to be increased. The RBI said this could not be done because Maruti was not compliant with existing rules for credit enhancement. It seems there were some sharp exchanges between Jagannathan, who was due anyway to retire in June 1975, and the finance ministry. He decided to leave a few weeks before his term was over. His critics said he had left because he was in a hurry to get to his next job as India’s executive director at the IMF.
Mrs Gandhi used the opportunity to appoint K. R. Puri, the chairman of LIC, with no previous experience of banking, to the job. His first act was to raise the credit limit for Maruti—and for everyone else—without consulting his colleagues. The RBI, and surprisingly, even the finance ministry fulminated, but there was precious little they could do. The Emergency was on and Sanjay Gandhi got what he wanted. No one dared to raise questions. In 1977, when the Janata government came to power, it removed Puri from the governorship within six months.
An interesting fallout of the Sanjay episode was that it led the RBI to move towards a “need-based” approach rather than a “security-based” approach to bank credit.
By this time monetary had given way to credit policy or, more accurately, credit rationing. The idea was to ensure that credit reached those who “needed it most.” The government decided who needed it most. The RBI didn’t like this. There was constant wrangling between the finance ministry and the RBI over credit rationing. The RBI was asked to behave when it tried to reassert itself. One of the worst culprits in this aspect was a government economist called Manmohan Singh.
Crisis: RN Malhotra is shown the door
1990 was the year of the perfect storm: severe political uncertainty at home, a near-bankrupt treasury, and global turmoil after Saddam Hussein invaded Kuwait. Malhotra was reduced to near-impotence. But by the end of the year the VP Singh government, which had succeeded the Rajiv government in December 1989, would be gone. So would Malhotra because the new prime minister, Chandrashekhar, wanted someone else as governor. That someone, ironically, was the man who had steered India towards the crisis—the brilliant and hands-on S. Venkitaramanan. It fell upon him now to steer it out of it. He did so magnificently, washing away his past sins as finance secretary.
The crisis he inherited had its basic causes in the highly loose fiscal policies during 1985–90. The proximate cause was the wrong decision taken by the new finance secretary, Bimal Jalan, to not go to the IMF when there was still time. This was in the first quarter of 1990 but Jalan, instead of taking a proposal to the Cabinet, second guessed it, and left it until it was too late. If blame is to be assigned for the crisis that overtook India during September–December 1990, it must be assigned to Jalan, who miscalculated badly. It was not his decision to take; it was the prime minister’s. Yet, he never took the file to V.P. Singh.
The result was that when the whole house of cards collapsed, India found itself close to default. No one would lend it any money.
When he walked onto the 18th floor of the RBI, Venkitaramanan was confronted with an absolute and total disaster. For one thing, no one really knew exactly how much foreign exchange reserves India had in the 1980s. At least two billion dollars were kept by the public-sector banks as undisclosed reserves in their overseas branches. Only five or six people knew about them: the governor of the RBI, a deputy governor, the finance secretary, the chief economic advisor and the joint secretary in charge of external finance. Rajiv Gandhi finished off even this money because he didn’t want to go to the IMF. The SBI had borrowed over two billion dollars for oil imports and even that was finished. By December 1990, the SBI in New York barely had enough to meet the minimum balance required by the Federal Reserve of New York.
On 1 January 1991, India had just $1.1 billion in its reserves. It was broke as never before and it was up to Venkitaramanan now to keep the balls in the air. He spent sleepless nights and anxious mornings but somehow kept the Indian ship afloat. For those six months he was the real hero because, to make things worse, Rajiv Gandhi, despite being told of the economic situation, had pulled down the Chandrashekhar government. It was an unprecedented act of irresponsibility for which he has never been held to account because he was killed by Tamil Tigers (LTTE) during the 1991 general election.
By mid-February, it had become clear to the government that it would have to mortgage its gold to get dollars. In an utterly courageous decision, Chandrashekhar allowed it. Venkitaramanan was charged with supervising the shipping of the gold, all 48 tonnes of it, to the Bank of England. He pulled off the feat almost without anyone knowing. It was only towards the end of the shipment that a newspaper got wind of it.
In June 1991, the new government headed by P. V. Narasimha Rao came to power with Manmohan Singh as finance minister. The two of them took charge and Venkitaramanan’s role was curtailed thereafter.
Excerpted from TCA Srinivasa Raghavan’s book A Crown of Thorns: The Governors of the RBI with permission from Westland and Tranquebar Press. We welcome your comments at firstname.lastname@example.org.