Victim of tirade

A loose cannon does not usually have a target, but Bharatiya Janata Party Member of Parliament Subramanian Swamy found his when he aggressively sought the ouster of the Governor of the Reserve Bank of India, Raghuram Rajan. The cannon fired thrice since May; in three missives to the Prime Minister, and in comments to the media, Swamy mixed innuendo with slurs on Rajan’s “patriotic” credentials and demanded his immediate sacking.

He also found fault with Rajan’s handling of the economy, especially the “high” interest rates that were hurting Indian industry. In doing this he was seeking to make common cause with not only the extreme right-wing within his own party but also with sections of industry that are irked by a rule-bound policy regime Rajan was committed to. Critics of the government’s policy have said that the rule-bound regime he has been pursuing is rooted in economic orthodoxy, which vests too much in monetary policy instruments, but that is another matter.

Even as Prime Minister Narendra Modi and Finance Minister Arun Jaitley watched silently, refusing to rein in the loose cannon, speculation mounted in the media and the markets on whether Rajan would continue after the conclusion of his current term in September. Rajan could not have been blamed if he presumed that his time was up at the helm. On June 18, the RBI Governor, a former chief economist at the International Monetary Fund, announced that he was not available for a second term. In a letter addressed to the RBI staff, he said he was going back to academia. Rajan is the first RBI Governor since 1992 not to seek a second term.

By the time Prime Minister Modi spoke with some clarity on the issue for the first time, on June 27, the damage had been done. Forty days after Swamy’s first salvo, Modi, in an interview with a news channel, obliquely rebuked Swamy by decrying the resort to “publicity stunts”. He also issued a certificate of Rajan being “no less patriotic than any of us”.

A man with his own ideas

What explains the long silence and the refusal to rein in Swamy and his tirade against the RBI Governor? Part of the explanation surely has to do with Rajan’s quick-witted repartees to some of the government’s policy proposals, among them Modi’s pet project, “Make in India”. Rajan pointed out that a global economy hit by recession was hardly conducive to an export-led growth strategy. Instead, he suggested that a “Make for India” strategy based on using the demand potential within the country would be a more worthwhile pursuit.

Later, when the Finance Ministry floated a proposal to establish a single bank that would take over the bad loans in the banking system—a “Bad Bank”, as the media called it—Rajan thought the idea to be a dangerous one from a systemic point of view. He pointed to the moral hazards in such a proposal and suggested a more aggressive clean-up of bank balance sheets.

Rajan also countered the idea, floated by Chief Economic Adviser Arvind Subramanian, that the RBI’s reserves could be used for recapitalising the banks. His response after the Dadri lynching, in which a man was killed for having allegedly consumed beef, was telling. Speaking from a purely liberal perspective, he articulated the idea that economic liberalism was incompatible with intolerance, bigotry, prejudice and hate. All this indicated that Rajan was unlike many who had held his post earlier and was always unafraid to speak his mind. More importantly, Swamy’s utterances against Rajan, notably his accusation that Rajan has “wilfully” and “deliberately attempted to wreck the Indian economy”, reflect the angst among sections of Indian industry that the single-minded pursuit of inflation targeting using high interest rates had doused the possibilities of an industrial recovery.

It is true that Rajan’s quest to rein in inflation at all costs has placed overwhelming importance on monetary policy tools, especially interest rates. But Swamy’s accusation that Rajan has wrecked the economy as a result misses some vital facts. First, Rajan is hardly the first RBI chief to do this; successive governments, most notably those headed by Manmohan Singh, had surrendered all other policy tools in exchange for monetary policy instruments. This was done in the guise of allowing the central bank a measure of “independence”, as if economic policy ought to remain in the realm of technocrats without being accountable politically in any way.

The second aspect that is missed in this tirade against Rajan pertains to the fact that Indian banks, particularly those in the public sector, have been burdened by the massive build-up of non-performing assets in their portfolio. It is true that Rajan’s aggressive pursuit of cleaning up bank balance sheets has resulted in accelerated provisioning of these banks, which hit their profitability and led to a spectacular collapse of their share prices earlier this year.

However, to blame him for this is surely self-serving advice, especially when it is articulated by the Indian corporate sector, which is primarily responsible for the burgeoning problem of bad loans.

Vijay Mallya may symbolise the rogue borrower, but he is hardly the only one who has caused grief to the banks. Several other industrial groups—especially those operating in the infrastructure and steel industries—owe much more to the banks.

Among them is the Gujarat-based Adani Group, which has outstanding loans that are several multiples of what Mallya owes. There is consensus in industry that banks have turned extremely risk-averse for two main reasons. First, the accelerated provisioning norms that Rajan introduced made lending that much more difficult. Second, because the provisioning affected profitability, they became even more risk-averse. This has obviously affected banks’ interest margins—the difference between what they pay depositors and what they earn from lending operations. Seen in this context, Swamy’s call for a reduction in interest rates is at best illogical; at worst, it is nothing but an espousal of what self-seeking industrial interests want after putting Indian banks in danger.

Obsession with inflation

Of course, this is not to say that Rajan is diametrically opposed to economic orthodoxy in the matter of economic policy. It is just that he believes that inflation targeting is critically important for macroeconomic stability, even if it means using a consumer price index that is far removed from the reality of peoples’ lives. For example, the index is constructed in such a way that the weightage for food articles is very low.

It is also important to recognise that Rajan became a darling of the Indian media and the markets precisely because of this fixation with inflation.

After all, those who rely primarily on assets to earn incomes fear inflation like the plague because they see it as eating into their returns; in contrast, workers also fear inflation but they are ready to tolerate it in moderation if they can find jobs. Rajan’s other supposed sin, the accelerated clean-up of bank balance sheets, can also be explained by his own vision for Indian banking.

He sees this as a way of making banks “healthy” so that they can be made more “competitive” and “efficient”, euphemisms for their eventual privatisation. This is because he, like everyone else, recognises that the public sector banks cannot be put on the anvil in their current state.

The Finance Ministry and the RBI were also at loggerheads over the composition of the Monetary Policy Committee, which will be entrusted with the task of determining monetary policy and the inflation target. The government, seeking the upper hand, wanted a say in determining the policy targets, but Rajan was reportedly in favour of retaining the central bank’s independence in this matter.

On June 27, the government notified the rules determining the composition of the six-member committee, which ensures that the government will have a significant say in the matter but the casting vote in the event of a tie would vest with the RBI Governor. Meanwhile, the government has announced a shortlist of four contenders to replace Rajan—RBI Deputy Governor Urjit Patel, former Deputy Governors Rakesh Mohan and Subir Gokarn, and State Bank of India Chairperson Arundhati Bhattacharya. Rajan’s departure from the RBI is not based on any key disagreement over the course of economic policy. Nor does the manner of his departure indicate any ideological differences. But it does reflect the mindset and approach of the Modi government.

First, it reveals a serious discomfort with anyone with a modicum of a liberal approach, in economic matters or otherwise. Second, Modi’s long silence in the face of the relentless tirade against Rajan shows that the political authority is willing to let fly loose cannons to attack inconvenient targets. The third aspect of the Rajan affair is that the government is willing to remove any obstacle in order to appease Indian corporate interests.

In hindsight, Swamy may well not have been a loose cannon. Instead, the Rajan affair may well be one more instance in which doublespeak from within the Sangh Parivar, combined with silence at the helm at crucial junctures in the episode, may have been used to obtain a result that the government wished for anyway. If that were to be true, it would be in keeping with the mode of governance that has been the hallmark of the Modi sarkar .