The Big Picture – Raghuram Rajan’s Last Policy: What’s his Legacy?

  • August 23, 2016
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The Big Picture- RSTV
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Raghuram Rajan’s last policy: What’s his legacy?


RBI Governor Raghuram Rajan will be demitting his office on September 4th 2016 after completing 3 year term. Rajan was not given the extension which the last four Governors had the benefit of. Rajan’s tenure has been extremely interesting, his job approach had been different and has received accolades from across the world.

Major contributions

  • When Rajan assumed the office in 2013, the rupee was under immense pressure, the current account deficit (CAD) was very high almost touching 3% of GDP and there was a macroeconomic instability with high inflation, though reducing oil prices helped in calming the economy. With his policies, he has left behind a very stable macroeconomic environment.
  • The problems were handled very deftly. Innovative ways used to shore up India’s foreign exchange reserves. The bonds which were issued with RBI’s guarantee on foreign exchange risks were well taken care of. Thus, macroeconomic stability is the biggest contribution.
  • Rajan brought great deal of predictability in setting up monetary policy and removed the unpredictable nature of RBI’s monetary policy.
  • With his stature in the international domain, the credibility of the central bank and the policies got much recognition.
  • Took a big bold step in codifying the relationship between the Union Finance Ministry and the RBI. In the larger interests, he has agreed to the terms, the monetary policy framework initially and now the monetary policy committee framework, with the sovereignty of RBI to a larger structure.
  • On-tap licensing is a major contribution in the country which is underbanked. There is more need of financial intermediaries. Today, almost 70% of the banking assets are in public sector banks. Since, the public sector banks are not being privatised, the only way is to inject more competition in the system. If there are more banks, hopefully the share of banking assets in public sector will come down. Being underbanked country, more the bank, better the share of finance sector in GDP.


Legacy leaving behind

  1. Over past three years, whole monetary policy framework has become much clearer. Inflation target has been fixed at 4% for 5 years by Monetary Policy Committee. It is however little too tight in country like India which is geographically diverse and where markets are not fully integrated.
  2. Forcing banks to be clear about their non-performing assets (NPAs) instead of hiding them. Also advised them to have clear process of transition
  3. Opened up finance sector to new entrants. For example, new banks, payment banks, putting bank licences on tap (On-tap licensing), small bank licences etc. In long run, it will be seen as Rajan’s most valuable achievement in Indian economy.

Working of MPC

Rajan will be the last RBI Governor to chart out the monetary policy. The next monetary policy will be formulated by Monetary Policy Committee. The Committee has a potential to evolve in a manner so as to dilute the powers of the Governor.

MPC is a 6 member committee, out of which 3 members are appointed by the committee that is headed by a cabinet secretary. RBI has only 3 members— the Governor, a Deputy Governor and another official.

A search committee will recommend three external members, experts in the field of economics, banking or finance, for the Government appointees. Thus, RBI governor has to manage a consensus. So, what he can do is that he has to get those 3 members and then if he cannot get it by consensus, then he has to use the deciding vote.

The MPC will meet four times a year to decide on monetary policy by a majority vote. And if there’s a tie between the ‘Ayes’ and the ‘Nays’, the RBI governor gets the deciding vote.

The number of times the RBI Governor uses the deciding vote will make an impression that the committee is not in consensus. So the onus will be on next Governor to find a consensus. Thus, deciding vote is a good way of keeping a check.

Rajan was comfortable with the deciding vote concept whereas many were of the opinion that the Governor should have a veto power. The issue of interest rate policy has been politically charged. In an environment where this sense of political importance is increasing, the MPC gives the RBI Governor a certain line of protection.

It is not entirely clear as to who will in future appoint the Dy. Governor because the answer given to the Parliament was that the appointment process of Governor, Dy. Governor and all other regulatory heads will henceforth be by a search committee called the ‘Financial Sector Regulatory Committee’.

There is nothing wrong in having a tension between the Governor and the Finance Minister on policy issues as there is an interplay of fiscal policy and monetary policy. Such frictions help to evolve better economic policies. Governor has an impact on fiscal policy because he has put lot of pressure of putting fiscal house in order to have loose monetary policy.

Problems pertaining to bank

The problem with the banks is that they have been under-regulated. There has been enormous amount of mismanagement of public funds and it comes out of the situation where government is the owner of 14 big banks. So, government effectively functions as a regulator. The ministry of finance regulates it. So, the RBI is not active in regulating the banks. So, RBI has to macro manage the banks.

However, if RBI wants to be regulator, it has to withdraw directors from boards of banks.

There has always been a problem about the exercise of the PSBs ownership functions. The new Bank Bureau under Vinod Rai may help to provide a certain barrier to both:- excessive political direction which was there because of the way in which the government exercise some of the functions and equally of possibility of micro-management on RBI side.

The RBI is acting like a merchant banker to government, it is managing the government’s borrowing programme. Thus, there could be a clash between that responsibility and its responsibility as a macroeconomic manager and also as regulator of securities.

In the long run, it will be in interest of the RBI to focus its work on macro management with MPC and delegating inflation control to RBI. The memorandum says that RBI is responsible for the inflation control.

RBI does not need more power to regulate the interest rates which were freed a long ago with interest rate ceilings, administered interest rates etc. However, banks have not passed on the benefits to the customers. Consequences is that we have highest spreads for banking in the world. Nowhere in world there is gap of 9% rate gap. There is 2-3% gap between deposit rate and advances rate.

However, certain areas where he wanted to do more but could not do more.

  • Regulation of the banking system. Too much of interference through the regulatory system because of many PSBs and government must have asked the RBI to exercise the ownership responsibility. Hence, banking regulation could not be made light and effective
  • Debt management office- RBI is wearing so many hats that there is some inherent internal conflict.
  • Bond market- government securities have to be backbone of bond market. RBI is insisting all the time that they will issue it and they will regulate. They should be regulated by SEBI. So, there is constant turf war.


For the first time, the country is aware of the existence of RBI Governor in a larger sense. Previous Governors used to remain low key but Rajan made his views public whether agreeing or disagreeing with the government.

The last RBI policy was left unchanged leaving a clean slate for the successor to work on. It means that when Rajan assumed the office, the rupee was declining rapidly, the inflation rate was at 9% and there were major economic problems. Hence, whoever takes over from Rajan does not have an immediate monetary policy problem to cope with.

The results of his action will be reaped in a period of time as the changes are fundamental. Hence, the new structures will take time to show results.

However, the successor might have a tough time to adjust into a new role wherein government will always be watchful.

Key words:

On tap licensing: virtually made banking licensing batch wise licensing that the window for licensing has been opened and everyone can submit their applications. It will allow eligible people for banking licence to apply at any time. It is not restricted to one phase that for next six months, the window is open.

Monetary policy: Central banks use monetary policy to either stimulate an economy into faster growth or slow down growth over fears of issues like inflation.

The theory is that, by incentivizing individuals and businesses to borrow and spend, monetary policy will cause the economy to grow faster than normal. And reverse is, by restricting spending and incentivizing savings, the economy will grow less quickly than normal.

Fiscal policy: The aim of most government fiscal policies is to target the total level of spending, the total composition of spending, or both in an economy. The two most widely used means of affecting fiscal policy are changes in the role of government spending or in tax policy.

Connecting the dots:

  1. The banking sector has witnessed reforms in past two-three years. Examine the major issues.

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