Modi@1 : Raghuram Rajan takes Round 1 on points as RBI-govt bout continues

By Siddharth Upasani

MUMBAI: Despite all their public pronouncements of a “cordial” relationship, the government and the Reserve Bank of India, for one reason or another have been in opposite corners of the ring during the Narendra Modi government’s first year in power.

Much like the build-up to the Floyd Mayweather-Manny Pacquiao ‘fight of the century’ that took place earlier in May, the months preceding the Modi government’s coronation were littered with ‘trash talk’ from both sides.

Senior Bharatiya Janata Party leaders criticised the manner in which Governor Raghuram Rajan was handling inflation. Rajan too, on his part, said in early May 2014 that the government could “fire” him if it wanted to, but the monetary policy would be set by him.

“The government can fire me, but the government doesn’t set monetary policy… I am happy to talk to the government, I am happy to listen to the government, but ultimately the interest rate that is set is set by me,” Rajan said at 44th St. Gallen Symposium in Switzerland.

And just like the Mayweather-Pacquiao clash, the last one year has seen the government and the RBI sizing each other up, throwing light jabs at moments considered opportune, but not culminating into the legendary ninth round slug-fest between Arturo Gatti and Micky Ward, which celebrated its 13th anniversary on Monday.


The start to the government’s term could not have been better. The government distanced itself from the pre-election Raghuram Rajan criticisms, and the governor welcomed the strong mandate garnered by the National Democratic Alliance.

At the 2014-15 (Apr-Mar) Budget in July, Finance Minister Arun Jaitley said the government, in close consultation with the RBI, would put in place a “modern” monetary policy framework. This was welcomed too, especially in light of the Urjit Patel committee report that recommended the creation of a monetary policy committee and a flexible inflation targeting framework.

But as headline retail inflation, the RBI’s nominal policy anchor, receded from near-double-digit levels in early 2014, the pressure on Rajan was steadily raised to reduce the “cost of capital”. In November, days before the RBI detailed its monetary policy, Jaitley pitched for a rate cut, saying the cost of capital must come down for reviving the economy.

However, Raghuram Rajan stayed pat on the repo rate until mid-January.


Raghuram Rajan’s Jan 15 off-policy rate cut conditioned further easing on “sustained high quality fiscal consolidation”, among other factors. However, in the lead up to the 2015-16 Budget, such high quality consolidation did not seem forthcoming after reports emerged of growing talks within the finance ministry of redrawing the fiscal consolidation roadmap to boost public investment.

But despite the government pushing forward the reduction in the fiscal deficit to 3% of gross domestic product by one year to 2017-18, the RBI announced another off-policy rate cut on Mar 4.

The RBI’s Mar 4 rate cut has been described in two ways. The first saw it as a necessary step following its Jan 15 call for high quality fiscal consolidation. Had a rate cut not followed the Budget, it could have been interpreted as a thumbs-down from the RBI.

The second explanation for the March rate cut saw it as a trade-off after the government approved the Patel committee’s suggestion of a flexible inflation targeting model.

While the government may have got the rate cuts it wanted — and the RBI its inflation targeting framework — the Budget also threw open several other contentious issues.


The first of these was the creation of a public debt management agency, something which the RBI is in favour of too. While both the government and the central bank have reiterated that they are on the same page as far as the debt management agency is concerned, the retraction of the concerned clauses from the Finance Bill, 2015 prior to its voting has raised questions.

A closer look at the Finance Bill shows that the public debt management agency would operate under the “general superintendence of the Central Government”. On the other hand, while the RBI has repeatedly said that it favours the creation of the said agency, it wants it to be “suitably independent” and away from influences.

The second, and far more controversial, proposal of the Finance Bill was the removal of the RBI’s control over state and central government securities. The amendment was not even mentioned by Jaitley in his Budget speech on Feb 28, and even caught Rajan off-guard.

The fact that Jaitley went on to retract both the proposals from the Finance Bill before its passage can be seen as two wins for Rajan. However, in the long-term, the die has been cast. A debt management agency roadmap is set to be discussed, while the removal of gilts from the RBI’s purview was suggested several years ago by Rajan himself, albeit with some degree of co-ordination given that the central bank may have an “ongoing legitimate interest in determining who participates in these markets”.

“…it is imperative that the regulators work out respective responsibilities so that the functioning of the markets is not impeded,” the Raghuram Rajan-led committee on financial sector reforms had said in 2009.


The new financial year began on solid note for the government-RBI partnership, with Modi singing Rajan’s praises unabashedly on Apr 2, and Rajan supporting the government in New York on Tuesday, remarking that expectations from the Modi government were “probably unrealistic”.

With the end of Modi’s first year at the helm, it can be argued that Rajan and the RBI have edged it. However, the government’s parries can be evaded only for so long.

New challenges, in addition to those yet to be completed, lie ahead. Foremost of them is the creation of a monetary policy committee. While both the government and the RBI seem to be in its favour, the devil again is in the details, namely, the composition of the committee.

While they will insist that they are on the same side, the nature of the government and RBI’s operations mean that they will be at crossroads at some point or the other.

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