The money man

THE GUARD in dark brown livery manning the 18th floor at the Reserve Bank of India (RBI) building overlooking the centuries-old, British-built Mumbai docks is unusually chatty. He talks easily of the powerful men and women who throng the vast offices on that floor, especially the man who has so severely divided opinion these days on his handling of the economy. The guard says it’s impossible to tell if the central bank’s governor, Duvvuri Subbarao, 62, is in office. Unlike his predecessor, who made it known when he was around, Subbarao is quiet, unobtrusive, and self-effacing. He seldom stays late at work or comes to office on holidays.

Yet, Subbarao is anything but inconspicuous. Fiercely conscious of RBI’s autonomy, he has trusted his own instincts in formulating policy, often beating a singular and unpopular path that has frequently put the government on notice and spooked the markets. At the same time, he has climbed down from the governor’s lofty perch and attempted to forge deeper links with his constituency. Heavyweights such as Aditya Puri, managing director of HDFC Bank, India’s second-largest private sector bank, and Anoop Singh, director (Asia and Pacific) at International Monetary Fund, find Subbarao candid and transparent in his policies. Even K. Venkataraman, managing director and CEO of the relatively smaller Karur Vysya Bank from South India, says that Subbarao is very approachable. “No other governor has communicated with us more openly.”
In the three years that Subbarao has been at its helm, RBI has shed its veil of secrecy and adopted the same tactics that endear companies to stock markets—giving guidance on interest rates. Subbarao meets analysts regularly to apprise them of what RBI thinks and puts out minutes of monetary policy meetings. He and his top team field questions from the media each time after policy announcements.

Usha Thorat, director, Centre of Advanced Financial Research and Learning (Cafral), and ex-deputy governor, RBI, says that if there is one thing Subbarao is fastidious about, it is to make things clear and simple. He fusses over commas, full stops, and language, and personally edits bulletins that are released to the public. “When he started his transparency drive, many in the RBI were worried about what he was doing,” she says. Thorat has been at the central bank for nearly four decades and has worked closely with five governors, including Subbarao.

His critics, though, say his handling of the economic crisis has been less than exemplary and totally uninspired. His stubborn notion that rising interest rates (hiked 13 times since March 2010) will temper inflation—the wholesale price index (WPI; the inflation metric) is still stuck at 9.1%—has been under attack for some time now. For corporate heads, the higher rates have made loans more expensive and hurt the economy. Lately, his willingness to allow the rupee to devalue to record lows—Rs 53.88 on Dec. 14, 2011—against the dollar has also been criticised.

Abheek Barua, HDFC Bank’s chief economist, for example, argues that the RBI’s hands-off approach towards the rupee just cannot work. “If it wants to keep inflation in check, it will have to find ways to slow the depreciation of the rupee by intervening in the forex market, otherwise imports will get costlier. This in turn will be transmitted into the overall system, and that’s already beginning to happen.” Adding to India Inc.’s misery is the higher cost of repaying foreign currency convertible bonds and the increased cost of imports, which are squeezing margins.

Rajiv Kumar, secretary general, Federation of Indian Chambers of Commerce and Industry, an industry lobby, has criticised Subbarao for not giving enough time for the transmission effect of interest rate increases to take place. “Interest rate hikes take seven to eight months to feed into the real economy. The governor could have pushed the pause button for a while before raising it again to study the real impact of the policy decisions,” he says. For the first time in eight meetings, at the mid-quarterly review of monetary policy in mid-December 2011, the RBI didn’t alter rates.

WHEN SUBBARAO WAS HANDED the top job on Sept. 5, 2008—the 20th Governor since Independence and the fifth since de-licensing—he seemed the wrong man at the wrong place at the wrong time. Days after he took charge, the global financial markets went into a tizzy. Lehman Brothers went bust, spooking financial markets and central banks across the world. Having served as finance secretary prior to his ascendency, Subbarao was comfortable with macroeconomics and fiscal policies but had little experience in managing monetary policy.

More important, he knew little of banking and regulation. The only advantage Subbarao had was that he took over from Y.V. Reddy who had ring-fenced the Indian financial system from global shocks by keeping a tight leash on the monetary policy. Says a senior RBI director: “Within the central bank there was apprehension—will Subbarao even understand what we tell him?”

In some ways, the situation was similar to when Alan Greenspan was appointed chairman of the Federal Reserve Board in 1987. He’d taken over from the legendary Paul Volcker, who was considered the second-most powerful man in the U.S. after President Ronald Reagan. In comparison, Greenspan’s credentials were hardly impressive. He was a mild-mannered former professional jazz musician, a self-made millionaire, and a Wall Street forecaster with a passion for numbers, as Steven Solomon describes him in his book on central bankers, The Confidence Game. In October, two months after Greenspan took over, the infamous Black Monday happened. Markets around the world crashed, setting off a global financial crisis.

Last August, the government extended Subbarao’s term by two years. A few months before that, Subbarao had spoken against the government’s effort to curb the independence of the RBI (he publicly criticised the government for trying to set up an independent debt management office under the finance ministry) prompting observers to suggest that he might not get a second term. (His three immediate predecessors served five-year terms.) Often, over the past year, finance ministry officials, including chief economic advisor Kaushik Basu, have publicly differed with Subbarao. Yet, the beleaguered finance minister, Pranab Mukherjee, who has not been able to push through any fiscal reforms, supports Subbarao. In the second week of December, he subscribed to Subbarao’s view that there was a need to contain inflation while addressing issues of growth.

Meanwhile, the past three months have been brutal. The stock markets are down; the rupee has crashed; the inflation rate continues to run high; the government is muddling through policy changes even as the global economy is veering off the rails. The biggest blow: In the second quarter of 2011-12, GDP grew at a rate of 6.9%, the lowest in two years, and industrial production turned negative in October, contracting by 5.1%. And, in his 18th floor office, Subbarao is getting ready to do what he believes is his mandate—the right thing for the economy.

TO UNDERSTAND SUBBARAO BETTER, those close to him point to the books that have deeply influenced him. His favourites are the ’70s bestseller, Robert Pirsig’s philosophical novel Zen and the Art of Motorcycle Maintenance, and Joseph Heller’s much acclaimed Catch-22. Over the years, Subbarao has read them several times, maintaining that his understanding of the books has increased as his own thinking has matured. He quotes from Catch-22 often. He once remarked to a colleague at RBI, “As I read them, I gain a different perspective on the way I think about issues.”

Months into his job, while the global financial crisis was raging, Subbarao realised that overseas financing was drying up quickly for Indian banks and companies, forcing a liquidity crisis in the country. As foreign institutional investors (FIIs) unwound their position and withdrew dollars, the rupee abruptly depreciated, and, coupled with a bearish stock market, it resulted in a crisis of confidence within the Indian business community. The very existence of mutual funds and non-banking financial institutions was threatened as investors chose safe-haven savings bank deposits. The knock-on effect began spreading quickly to the real sector with exports nose-diving as dollar credit became scarce.

Fresh from his stint, Subbarao mirrored what the finance ministry was thinking at that time. For starters, in consultation and coordination with the finance ministry, Subbarao turned on the liquidity tap—infusing as much as $75 billion (Rs 3.75 crore) into the system—to ensure that there was ample dosh for all the sectors of the economy. Policy rates—both repo and reverse repo (rates at which banks borrow from RBI and vice versa)—were reduced, as was the cash credit ratio (the ratio of cash in the bank to the loans given by it); the statutory liquidity ratio (the amount of liquid assets such as cash, precious metals that a bank must have in its reserves) was lowered and a special funding facility to provide liquidity to mutual funds, was started. While most central bankers would have put a check on liquidity, Subbarao’s move was seen as populist and more humane.

SUBBARAO DID THINGS that a lot of RBI directors weren’t happy about. For the first time, he wanted to offer an additional line of credit drawn from the National Housing Bank (NHB) and Small Industries Development Bank of India (SIDBI) to specific sectors such as real estate and small scale industries. For old timers, a move like that was strictly a no-no as they knew that the government would want to use the same weapon when it was in trouble. Says Thorat: “We argued against it a lot as we thought that going for liquidity overkill would only fuel high inflation which would be tough to bring down even if interest rates were raised later.”

His handling of the disagreement gave RBI insiders a peek into how he worked. Unlike Y.V. Reddy who often told his deputies what to do, Subbarao is seen as a consensus builder. (He calls himself “collegial”.) Reddy, says Thorat, would be bubbling with 200 ideas each day and assigned jobs to his senior managers. Subbarao relies on his deputies to come up with ideas and draws them into a lot of internal debate. He also doesn’t surprise his senior executives by walking into their offices and asking them about pending issues. Instead, he gets his office to call their secretaries, and provide them with the governor’s discussion agenda, and a time for the discussion. Says a director on RBI’s board: “That way, he sends a clear message that he wants to hear what we have to say rather than wanting to discuss something. It empowers us in a certain way.”

Thus, even though there were dissenting voices to increasing liquidity, Subbarao got them to agree that companies would be in trouble for no fault of theirs and they needed help. Recalls an RBI senior general manager: “After we heard him, most of us were convinced that having an outsider at the helm during such a crisis was a good thing after all.” And Subbarao got everyone behind his bailout plan.

Not that he needed to. Thorat says in RBI the onus for policy decisions finally falls on the governor, who has a right to veto anything that’s put to him. But, being a successful bureaucrat taught Subbarao the virtues of carrying his bosses and teams along. His early stint of being a district collector also made him empathetic—evident from his efforts at goading banks to open upcountry branches to expand financial inclusion. He even sends senior managers to remote parts of the country to study and explain the relevance of RBI through town hall meetings. Known as the outreach programme, many initially resisted the programme, but it has now become normal fare. Says senior general manager Krishnamurthy, who is now on deputation to Cafral: “The exercise took you away from all the numbers and showed a practical purpose for policy decisions.”

Indeed Subbarao’s approach indicates more populist measures in making banking more approachable to the public. Giving awards to small entrepreneurs at an event organised by Citibank in Mumbai recently, Isher Judge Ahluwalia, chairperson of the board of directors of the Indian Council for Research on International Economic Relations said “the big change now is that banks view financial inclusion as an opportunity and Subbarao has been partly responsible for this”.

He has also taken a lot of unusual steps without creating much noise. Non-banking financial institutions, a no-go during crises, were accorded liquidity, and there was liberalisation and refinancing of export credit for exporters. A rupee-dollar swap system too was introduced to provide dollar liquidity to banks having international operations. The RBI expansionary monetary policy not only helped

India come out of the crisis without much collateral damage, but also ensured that the economy returned to its winning ways. After witnessing a fall in the growth in gross domestic product to 6.8% in 2008-09, after five years of 8.8% average growth, India was back on the growth path. It grew by 8% in 2009-10 and 8.5% in 2010-11.

Today’s tumult in the global economy has taken away attention from some of Subbarao’s recent efforts at RBI. Despite opposition from public sector banks and some of the larger private banks, Subbarao de-controlled the interest rates that banks could pay on savings deposits. For Rana Kapoor, who runs the fast-growing Yes Bank and has a very small percentage of savings deposit, it appears as the single-biggest reform in the banking sector after 1991. He says that the move will trigger an increase in overall savings, leading to investments in infrastructure and developmental projects. Kapoor says: “I hope to see the savings rate go up substantially from the current 37% to over 40% in the next 10 years.”

Again, at a time when RBI is grappling with the issue of allowing companies to set up banks, Subbarao has been categorical that the Banking Regulation Act of 1949 needs to be amended to include the right of RBI to change the bank’s board if it is not run the way it is supposed to be. He believes that it is necessary to prevent companies from using banks “as private pools of readily available funds”. Saurabh Tripathi, partner and director at Boston Consulting, says: “He is never afraid to stick his neck out and take on additional responsibilities as he showed in the case of issuing new banking licences to the corporate sector.’’

But, why is it that his handling of inflation has turned out to be such a hard sell?

ANY, INCLUDING A FEW RBI OFFICIALS, argue that Subbarao was behind the curve in addressing the inflation problem. He first cut repo rates from 9% in October 2008 and brought it down to 4.75% on July 2009. From March 19, 2010, he started increasing interest rates again. At 9.1%, India’s inflation is much higher than RBI’s comfort zone of 4.5% to 6%. The fact that inflation remains high has raised questions about the efficacy of monetary policy in managing supply-side shocks (insufficient supply of food, commodities and bottlenecks in their distribution).

The criticism against the former finance secretary becomes even more robust when the argument is turned towards higher food prices or food inflation. “Even when WPI was in the negative, food inflation continued to be high beginning from October 2008,’’ says Sunil Sinha, senior economist and head of research at rating agency CRISIL. And no amount of interest rate hikes have had any impact on the demand for food because it is driven by the higher purchasing power of rural folks and a change in dietary habits from cereals to protein-based items, he adds. The earlier belief that a good monsoon will bring down the prices of fruits, vegetables, milk and meat, no longer holds good because there has been a structural shift in the nature of food inflation.

Surjit Bhalla, chairman, Oxus Research and Investments, an economic think tank, says that no other central bank uses interest rates to address supply-side issues. “No other bank thinks that raising interest rates will affect food production.” Pronab Sen, principal advisor, Planning Commission, argues that monetary policy has little role in bringing down inflation because money supply was never a contributory factor in the whole issue of inflation.

Repeated hikes, instead of dampening demand, have only slowed growth by making capital more expensive and forcing India Inc. to postpone their investment decisions, when such investments are critical to bringing back confidence in the economy. “While it is true that Subbarao may have been able to accomplish the turnaround of the economy, he should now be questioned for not reading the inflationary pressures properly,’’ says a public sector banker.

The boom years of the economy have coincided with high corporate investments. And, with loans turning costly, most of India Inc. has lost the appetite for fresh investments, which is showing up in the industrial production numbers.

However, to say that Subbarao is unaware of such developments is to underestimate his intellect and his deep knowledge of the global economic situation. Any reading of his review of his quarterly monetary policy—he started the process of having such reviews every 45 days—should dispel any such notion. He espouses a different logic to explain his actions. In a speech last September at the New York-based Stern School of Business, entitled “Monetary Policy Dilemmas: Some Policy Perspectives’’, he said that higher interest rates have little or no impact on supply shocks only in two situations. First, when the price rise is only temporary in nature, and second, when it is driven by supply side shocks alone and nothing more. But that’s not true in most Indian cases, whether it is in the case of food items or in the case of commodity prices. “Persistent supply pressures on the food front can fuel inflation expectations, which, in turn, can trigger a wage-price [higher demand for wages because of increased inflation] spiral,’’ he said.

Sitting beneath portraits of past governors in his mammoth office, Subbarao explains the inflation vs. growth issue. Though he is a Ph.D. in economics and a topper in the IAS entrance exam, his early training was in physics—B.Sc from the Indian Institute of Technology (IIT) Kharagpur and M.Sc. from IIT, Kanpur. He tends to explain his position in a series of short, logical sentences.

To a question on his preoccupation with inflation, he emphasises that it’s his “personal view” and the “central bank’s view” that when inflation is this high, “you first need is to get it down”. He argues that the debate is driven by a “misunderstanding about the growth inflation trade off”, adding: “It is not that you can have high growth if you have high inflation. The short-term Phillips Curve theory [correlation between unemployment and inflation] has been discredited. We are working on the pro-growth platform. And it is our understanding that to get growth, we need to get inflation down. It is not the destination but the means to get to that destination.”

Ultimately, Subbarao doesn’t take a decision that does not appeal to his logic. The Raghuram Rajan Committee report on financial sector reforms in April 2008 recommended that bank loans to microfinance firms should qualify as priority sector lending. It also suggested that banks could then issue priority sector lending certificates (PSLC) and trade in them to enable other banks to meet RBI’s priority sector lending targets.

The central bank’s initial response was lukewarm, which made the prime minister’s office ask it to review its decision. The RBI then set up a committee headed by senior executive director V.K. Sharma to weigh the pros and cons of PSLCs. In the end, despite the fact that PSLCs would have indirectly increased financial inclusion, Subbarao rejected the scheme.

With most experts predicting a fall in the inflation numbers, especially food inflation (it has already dipped to 0.42% in the week ending Dec. 17, 2011), the worst may be over for the governor. Some of his recent policy announcements have also been far less hawkish. He is talking about growth and making efforts to stall the steep decline of the rupee. Time for the critics to let up?