RBI’s credibility loss: It’s wrong to blame Subbarao alone; UPA is equally responsible

The mid-year economic review of the Narendra Modi government has made some strong-worded, direct observations against former RBI governor D Subbarao saying the monetary policy lost credibility in the economy during his stint at the central bank.

“For nearly six years (2007 third quarter to 2013 third quarter), India lost monetary policy credibility…,” the review said. “That has been reversed since the end of 2013, with real interest rates climbing back into positive territory”.

The reference to the specific time-frame given here unmistakably proves the men for whom the words of blame and praise are intended — the blame for Subbarao, who was in office since 2008 until September 2013, and the praise for Raghuram Rajan, who took charge thereafter.

The ground for criticising Subbarao is this. Between 2007 and 2013, the RBI failed to contain inflation, letting price-levels soar to double digits, which in turn kept the real interest rates negative in the economy, while Rajan managed to kill inflation and turned real rates positive yet again.

One cannot disregard the government’s observations given that inflation has indeed consistently stayed at high levels during most past part of Subbarao’s tenure, snatching away the fruits of economic growth from the common man.

In September 2008, when he took over as RBI governor, the repo rate, or the key policy rate of the central bank, stood at 9 percent. Subbarao had to rapidly cut interest rates to release liquidity into the domestic economy. By the time he started raising interest rates in April 2010, through his so-called ‘baby steps’, the inflation scenario had gone out of hand.

Agreed, Subbarao is widely considered as a governor who acted behind the curve by not increasing interest rates sufficient enough to tackle a dangerous rise in inflation.

However, openly questioning the credibility of Subbarao’s monetary policy and putting the entire share of blame on the former civil servant is, perhaps, a bit unwarranted, considering that the benefit of luck, often a critical element to decide the success of a central banker, didn’t favour Subbarao as it did Rajan.

Shortly after Subbarao took over, the global financial crisis broke out, draining liquidity from the emerging markets, including India, forcing Subbarao to rapidly cut interest rates.

During his regime, almost everything worked against him.

The global growth was facing severe stress in the aftermath of the 2008 crisis impacting the prospects of domestic economy, the state of fiscal prudence, under the UPA government, was going out of control on account of massive populist measures and widening deficits, investor confidence was draining in the absence of reforms and corruption charges for most part of the UPA-regime.

In short, the monetary authority did not have any support from the fiscal authority, when Subbarao headed the central bank.

Since 2010, the inflation was gradually transforming to widespread, generalised inflation and not something solely confined to demand side pressures, which was the case until then. When inflation is propelled by supply pressures, the monetary policy could do very little to check price levels and price expectations.

Also, Subbarao, being Chidambaram’s man in the RBI, undoubtedly faced immense pressure from the government to keep interest rates lower.

The situation was much better when Rajan took over in September 2013 with sentiment turning positive overall. Under Rajan, a renowned international economist, the office of the RBI governor certainly commanded more power compared with the time of Subbarao, who was more of a consensus man.

In short, in the Subbarao era, if high inflation and resultant negative real interest rates for a long period meant loss of credibility for monetary policy, it is certainly unfair to blame the man alone.

The responsibility should be equally attributed to the UPA government’s policies that worsened the fiscal scene and adverse global economic conditions that would have made life difficult for any central banker in the aftermath of the 2008 global financial crisis.