Raghuram Rajan, former governor of the Reserve Bank of India, speaks during a television interview (Photographer: David Paul Morris/Bloomberg)

Davos 2019: Raghuram Rajan Bats For A Protected Term For The RBI Governor

Former Reserve Bank of India governor Raghuram Rajan said that the RBI Act needs to have some provision about the institutional independence of the central bank and its governor.

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“Going forward we need to think a little more whether this independence needs to be enshrined a bit more in the statute. Whether we need an act which protects the term and rank of a governor,” Rajan told BloombergQuint on the sidelines of the World Economic Forum in Davos, Switzerland. “We are reaching the place in our development where protecting and strengthening institutions will be very important.”

In order to have predictability we have to go through a process where there are checks and balances so the whims of someone in power cannot prevail.
Raghuram Rajan, Former RBI Governor

The comments come nearly a month after his successor Urjit Patel resigned following nearly two months of disagreements with the central government. Patel and Deputy Governor Viral Acharya both made public comments about the need to ensure central bank independence. Patel later resigned citing personal reasons and was replaced by former economic affairs secretary and veteran bureaucrat Shaktikanta Das.

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Rajan, now a professor of finance at the University of Chicago Booth School of Business, said the government can determine objectives of an independent institution. But once the marching orders are given, it should let the institution decide how those objectives can be achieved.

“In reality why you create independent institutions is because in the longer run it makes sense that even if those institutions are working for the longer-term benefit of the country, sometimes they have the ability to say no to the government,” Rajan said. “That’s notion of independence. It is not bloody-minded, it's based on the realisation that governments have shorter term aims some times and they themselves benefit from having that.”

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On Inflation

Rajan noted that lower inflation was a good thing for the economy but flagged higher core inflation. “The view of course is that core inflation will eventually feed into headline. So someone looking at headline inflation will also look at core and try to understand why it's high. But this is a technical discussion. Broadly speaking, there are still concerns whether we have killed the inflation beast completely. We've come a long way but with core at 5.6-5.7 percent, it's saying something about whether we're at the limits of capacity and whether we can afford to stimulate even more without seeing higher inflation.”

On Fiscal Deficit

The former central bank chief said that with fiscal deficit people have a tendency to get fixated with numbers. “The numbers aren't as important as the quality behind the numbers. You can reach 3.2 percent as your target but what you've done is put a lot of things off-balance sheet. That becomes problematic. This is something the CAG has pointed to in past budgets. I want to emphasise the normal level of postponement of off-balance sheet is okay but if it becomes extraordinary then effectively you haven't reached anywhere near your target.”

Watch the full interview here:

Here are the edited excerpts from the interview:

What to expect from the upcoming union budget?

At least at this point, it seems we are at the end stretch of this government. I don’t see the possibility of major reforms at this point. But clearly one of the achievements of this government has been to move towards broad macro stability. Inflation is down. There has been a process of fiscal consolidation with some questions about the quality but the direction has been towards more consolidation by the Centre.

Of course in the meantime states have expanded their fiscal deficits which overall is a problem. I think a beneficial legacy of this government will be for the last budget to be a responsible one. It should be one which doesn’t saddle the next government with significant legacy because already some expenditures are postponed and are off-balance sheet, as is typical, but if this becomes more than the normal then the next government has to deal with it and it creates problems for the future. So a broadly responsible budget because after all there is not much spending you can do in the short run that will create a political support. So really maybe outline the path for further reforms in necessary in the budget, but allow the next government to figure out how to take it forward.

What should be on the agenda of the next government?

In terms of the agenda for the next government, almost surely, way up there has to be how do we create more jobs. We have very strong growth, 7-7.5 percent, but it doesn’t feel like the jobs are being created to take people out of agriculture. We haven’t seen the kind of departures from agriculture that typically happened with China at this level of development. So how do we do that? How do we improve the quality and livelihood of people in agriculture and rural areas, but also allow the transition to semi-rural industries and create jobs there.

How do we create more semi-skilled jobs which are reasonable and of a good livelihood and allow them the possibility of transitioning to better jobs? These would be front and Centre for any new government. Part of the process is how do you get more growth in areas like infrastructure which can create the possibilities for unskilled jobs but also create more jobs in manufacturing and value added services.

Can India achieve its fiscal deficit target?

I think that at some level we get fixated with numbers. The numbers are not as important as the quality behind the numbers. You can reach 3.2 percent as your target but what you’ve done is put a lot of things off-balance sheet. That becomes a problematic. This is something the CAG has pointed to in past budgets. I want to emphasise the normal level of postponement of off-balance sheet is okay but if it becomes extraordinary then effectively you haven’t reached any where near your target. A lot depends on how fiscal deficit of states and Centre combined is much higher than that other large countries have. There is a very real question whether we can bring it under control. What mechanism do we have for the states to be more responsible, and what mechanism can we give to the world? Our investors, both domestic and international, what confidence can we give them that we are on the path to straightening it out, given our tremendous spending needs.

How can India control its fiscal deficit?

The reality is that there are a couple of things we could do far better to bring that number (fiscal deficit) under control. For instance, selling off some of our stakes in the public sector. Every time we set a disinvestment target, we never meet it. Even though the stock market is zooming through the roof. Somehow at that time we are paralysed and then the stock market collapses so we say we can’t sell because it is too low. But when are you going to do it?

To some extent we have taken it from one pocket to another with the public sector firms buying each other and that counts as disinvestment. I think there is a realistic possibility of disinvestment, there is a realistic possibility of accumulating government land and selling it in a more transparent process for the very real needs we have. In terms of resources and generating those resources, I think there are possiblities and we can do that without touching the so-called “family silver”.

There is also a possibility of raising revenue which we need to consider going forward. Without raising the tax rate tremendously, but trying to make some of the indirect taxes more effective and also collecting direct taxes from people who actually ought to pay. I think these are possibilities that lie in the future. If you look at total spending and total tax collection, it is pretty low relative to a industrial countries. There is a long way we can go. I am not advocating that we become a very high tax economy. We are not at the extreme by any means but we need to do a better job.

What is your take on India’s agrarian distress?

To some extent we have not appreciated the fact that we have the possibility of turning agriculture into a success story. There are places, I mean, we’re the largest milk producer in the world. I remember a time when milk was rationed and you couldn’t get enough for the family. And now we are in a very different position. So there are success stories. Animal husbandry has been a success story. We have had successes like we were exporting rice. Now whether we should be exporting rice because we are a water hungry country is a different issue. The reality is that government intervention in agriculture has been sporadic and often distortionary. And what we need to do is to rethink this whole process. It is not that other countries don’t intervene, but are there more effective ways of intervening.

Clearly the government has to do a more on technology dissemination and so on. We have opened a number of institutions which aren’t performing according to what they were supposed to do in terms of agricultural technology extensions. We need to relook at all of that. But also all these subsidies and distortions, government procurement doesn’t happens or happens, can we replace it by something which is more market friendly. Do we have to do it crop-by-crop, or can we just offer some kind of a blanket subsidy that okay if you own land we will pay you Rs X every year.We need to think about the tenant farmer too, so if you’re one who does the benefit go to?

These are things that some states have looked at like Odisha and Telangana. Explore what they did, see what worked, what didn’t work, what fixes need to be made. But don’t add this as yet another mechanism on top of the existing mechanisms. Try and do away with existing mechanisms. It has to be that this replaces the distortions because previous interventions aren’t working.

The reality is that the farm sector, that employs so many of our people, is distressed. And we need to do something about that in a more effective way which positions this industry for the future is really what would be the long term solution rather than a band-aid which we repeatedly offer to the sector.

The resources for that will have to be found because it is such an important sector. At the same time there is a temptation to create these schemes and not worry about the cost. Because the initial cost is like Rs 10,000 crore and that can be taken care of. But then that builds to Rs 1 lakh crore, and Rs 2 lakh crore. These entitlements are very hard to take away. I think one of things we need to do in the budgets is cost all these announcements not just for today but for the future budgets too.

We have health insurance, which is very costly. We cannot look at just today's cost in terms of the small number of people who access it. But when it is full rolled out, what will the cost be. These entitlements as we build up, we have to make sure that we can meet them down the line, because they will get harder to take away.

What about India’s falling inflation?

On the positive side, headline inflation is below expectations. Obviously result of fairly low food price growth. But countering that core inflation has picked up. When we set the inflation target our view was that we did not want to fudge by taking an easier target. We wanted the harder target which at that time was the headline inflation. The view of course is that core inflation will eventually feed into headline. So someone looking at headline inflation will also look at core and try to understand why it is high. But this is a technical discussion. Broadly speaking, there are still concerns whether we have killed the inflation beast completely. We’ve come a long way but with core at 5.6-5.7 percent, it is saying something about whether we are at the limits of capacity and whether we can afford to stimulate even more without seeing higher inflation. 

There have been concerns about the government curbing institutional autonomy. What do you think of that?

I think there is a misconception about independence which needs to be corrected. There is a sense that the government is elected by the people, the government has to determine the course and institutions should step in line when the government decides something. What is this talk of independence?

In reality why you create independent institutions is because in the longer run it makes sense that even if those institutions are working for the longer term benefit of the country, sometimes they have the ability to say no to the government. That’s notion of independence. It is not bloody minded, it is based on the realisation that governments have shorter term aims some times and they themselves benefit from having that. The government determines through legislation what the objectives of an institution are. Given those marching orders the insitutions have to determine how they achieve those goals. If it is financial stability, how it determines NPA norms for example. If it is monetary policy, what rate it sets interest rates at.

Over time we’ve had an understanding about the independence of the RBI. And I would say that the RBI, from that perspective, has been historically been given a fair amount of independence.

Going forward we need to think a little more whether this independence needs to be enshrined a bit more in the statute. Whether we need an act which protects the term and rank of a governor. There are so many levers the government has which if it wants to exercise, but again governments have been fairly careful about the process, basically imply that the institution has no ability to make independent decisions. But the country needs that. Therefore I think there is a need to rexamine whether in fact there is a need for enshrining this in the statute.

We are reaching the place in our development where protecting and strengthening institutions will be very important for what we do going forward. We need to have a process. Just now I came from a session on South Asia where one of the business people said we need predictability of decision. In order to have predictability they have to go through a process where there are checks and balances so the whims of someone in power cannot prevail. That allows business to plan. You know tariffs aren’t going to be changed on a moment’s notice, the regulations won’t be changed on a moment’s notice. There has to be a process. I think we are getting there but we need to think of what more we need to do because part of business is creating a predictable environment.