Imperatives for Reserve Bank of India – Agenda for Raghuram Rajan

ECON/044 IBS Center for Management Research

This case was written by Hepsi Swarna, under the direction of G V Muralidhara, IBS Hyderabad. It was compiled from published sources, and is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation.

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Licensed for use in the Case Writing Workshop at Bapuji B - Schools, Davangere on March 16, 2019. Faculty Nqame: Prof. G V Muralidhara.

ECON/044

Imperatives for Reserve Bank of India – Agenda for Raghuram Rajan

INTRODUCTION

On August 28, 2013, the value of the Indian rupee vis-à-vis the US dollar plummeted to a record low of INR68.80.The stock market took a plunge and on the same day, the BSE SENSEX touched an intra-day low of 17,720, down a whopping 13.6 % from January 2013’s high of 20,500. Foreign investors pulled out an staggering INR620 billion (USD10.5 billion) from the Indian capital market during June-July 2013 amid concerns over the depreciating rupee. Inflation in India had been running high at above 7% since December 2009; current account deficit had expanded to record levels (4.8% of GDP in 2012); and several projects were reportedly stalled due to policy bottlenecks.1 The investment climate was not seen as encouraging by corporates. In the first quarter (April-June) of the fiscal year 2013-14, India’s economy grew at its slowest in the previous four years and recorded a growth rate of 4.4%.2 In October 2013, the World Bank revised India’s economic growth forecast for the fiscal 2014 to 4.7 % against the earlier estimate of 6.1%.3 Experts pointed out that the Indian economic condition in 2013 was the worst since 1991. At a time when India was facing its worst financial and economic crisis in decades, with slowing economic growth, high inflation, a record high current account deficit, and the rupee hitting record lows, Raghuram Rajan (Rajan) was appointed as the 23rd governor of the Reserve Bank of India (RBI) on September 04, 2013, for a period of three years. The day after he was appointed, Rajan outlined a reform plan focusing on boosting investor confidence and stabilizing the falling rupee. As a result, the rupee and stocks strengthened. On September 05, 2013, the rupee gained 1.58%, going up to INR66.01 against the dollar and the stock market closed up by 2.22% to 18,979.76.4 By October 16, 2013, the rupee recovered by almost 9% since September 2013, to INR61.83 against the dollar.5 Rajan was described as a person with the Midas touch and was portrayed as a rock star governor, both in the national and international media, for stopping the rupee fall. Questions were, however, raised about Rajan’s capacity to bring India out of its economic crisis, given that he had control over only the monetary policy. Economists and analysts kept a keen watch on Rajan’s moves to see if he could contain the crisis in India and bring it back on growth path. The answer to this question was expected to matter not just to India but also to other emerging economies embroiled in a similar crisis.

1 “Economic Survey 2012–13”, http://indiabudget.nic.in, 2013 2 “Estimates of Gross Domestic Product for the First Quarter (April-June) of 2013-2014”, Press Information Bureau Government Of India, http://mospi.nic.in , August 30, 2013 3 K R Srivats, “World Bank lowers India’s GDP growth forecast for 2013-14”, http://www.thehindubusinessline.com, October 16 , 2013 4 “Raghuram Rajan comes in as RBI governor, rupee and stocks rise”, http://www.hindustantimes.com, September 05, 2013 5 Sachin Kumar, “The Rajan effect: rupee rises again”, http://www.hindustantimes.com, October 16, 2013

BACKGROUND

In 1926, the Royal Commission on Indian Currency (Hilton Young Commission) recommended the establishment of a central bank to be called the Reserve Bank of India (RBI). On March 05, 1934, the Reserve Bank of India Act, 1934, (II of 1934) was passed which provided the statutory basis for the functioning of the RBI. On April 1, 1935, the RBI commenced its operations with Sir Osborne Smith as its first Governor. The Bank was constituted as a shareholders' bank6.7 In one of the major events at the RBI, in 1938, the first RBI notes were issued. The RBI was formed to: regulate the issue of bank notes; maintain reserves with a view to secure monetary stability; and to operate the credit and currency system of the country to its advantage.8 The RBI’s monetary policy throughout its history focused primarily on inflation control and expansion of bank credit to support economic growth.9 By 2008, with the development of a broad- based financial market with closer global inter-linkages, financial stability was included as another important objective of monetary policy in India

POST INDEPENDENCE EVENTS

A major milestone in the history of the Reserve Bank was its nationalization in 1949. The RBI was nationalized with the passing of the Reserve Bank of India (transfer to public ownership) Act in 1948. In terms of the Act, all the shares were transferred to the central Government on payment of compensation to the shareholders.10 Thus, after January 1, 1949, the Reserve Bank of India functioned as a state-owned and state-controlled (nationalized) bank. The nationalization of the RBI was also supplemented by the passing of the Banking Regulation Act, 1949, conferring on the central bank the vast power to control the activities of the commercial banks. In the same year, the Banking Companies Act (later renamed as the Banking Regulation Act) was passed, which required the banks to maintain liquid assets for the first time. On September 19, 1949, the rupee was devalued by 30.5% as a defensive measure, due to devaluation by other ‘sterling area’ countries.11 After 1951, there were major changes made in India’s economic and monetary policies. In 1951, five-year plans were launched, which took India toward a more planned economy. The State Bank of India was formed in the year 195412, to bring rural credit to the center stage of central bank activism. On October 6, 1956, to meet the expanding currency requirements of the economy, the system of note issue changed from the Proportional Reserve System (PRS) under which the RBI was required to maintain 40% gold and forex reserves against note issue, to a Minimum Reserve System (MRS)13.

6 Initially, the RBI was established as a shareholder’s bank. Its share capital was INR50 million, divided into INR0.5 million fully paid up share of INR100 each. Out of this, shares of the nominal value of INR0.22 million (2200 shares) were allotted to the Central Government. The remaining share capital was owned by the private individuals. Thus, the control on the policy of the RBI remained with the Government. 7 Reserve Bank of India, “Chronology of Events: The Early Years – 1935 to 1949”, http://www.rbi.org.in 8 Reserve Bank of India, “Chronology of Events: Brief History”, http://www.rbi.org.in 9 Amaresh Samantaraya, “Monetary Policy of the Central Bank:Simplifying the Mystique”, http://cab.org.in, April-June 2008 10 “Role of RBI in Indian Economy”, http://www.scribd.com 11 Reserve Bank of India, “Chronology of Events: The Early Years – 1935 to 1949”, http://www.rbi.org.in 12 “Glimpses of RBI’s history”, http://www.bankbazaar.com, January 21, 2010 13 Minimum Reserve System means that the RBI can issue any amount of currency notes provided it keeps the minimum statutory limit of INR2 billion in gold and government securities, of which INR1.15 billion should be in gold.

In 1960, the policy of reconstruction/compulsory amalgamation of banks was introduced to consolidate the banking sector.14 Around 200 banks were merged or liquidated between 1960 and 1982.In 1962, H V R Iyengar, RBI governor from 1957-1962, identified four areas of conflict between the RBI and the government –interest rate policy, deficit financing, cooperative credit policies, and management of sub-standard banks.15 Under his leadership, the monetary policy for the very first time used the variable Cash Reserve Ratio (CRR)16 and selective credit controls. In December 1967, social controls over banks were introduced in India to align the banking system with the needs of the economic policy. As a result, 14 major Scheduled Commercial Banks (SCB) with deposits of INR50 million, were nationalized for the development of the economy. After the nationalization of the banks in the late 1960s, monetary policy in the form of credit planning17 assumed a lot of importance. During the early 1970’s, inflationary trends in the country led to the initiation of strong measures by the RBI. To tame inflation, the RBI increased the Statutory Liquidity Ratio from 25% to 28% and hiked the bank rate18,19 In 1973, there was an oil shock, wherein oil price quadrupled, resulting in double digit inflation and recession in the country. To deal with this, the RBI implemented a series of measures to contain the expansion of bank credit. Another major development was that the Foreign Exchange Regulation Act, 1973, came into force on January 01, 1974, to conserve foreign exchange. To increase its focus on rural development, the RBI set up Regional Rural Banks (RRB) in 1975 as alternative agencies to provide credit to rural people.20 In the 1980’s, the monetary policy regime which was heavily regulated, was constrained by a high level of deficit financing, priority sector lending, controlled interest rates, and an outdated financial sector. It was against the backdrop of these obstacles that the Chakarvarty Committee in 1985 reviewed the functioning of the monetary and banking systems of India and made some recommendations. According to the Chakarvarty Committee’s recommendations, a flexible monetary targeting approach21 was introduced as the basic framework of monetary policy.22 The other recommendations included emphasis on price stability and economic growth, coordination between monetary and fiscal policy to reduce the fiscal burden on the former, and a scheme of interest rates in accordance with valid economic criteria.23 Another noticeable shift in the monetary policy was the introduction of money market reforms following the recommendations of the Vaghul Committee in 1987.24

14 Reserve Bank of India, “Chronology of Events: Institution Building– 1960 to 1971”, http://www.rbi.org.in 15 Y.V. Reddy, “Monetary and Financial Sector Reforms in India: A Practitioner's Perspective”, http://www.economics.cornell 16 CRR is a legal obligation on scheduled commercial banks to maintain certain reserves in the form of cash with the RBI. 17 Credit planning included regulating the quantum and distribution of credit flow to various sectors of the economy, in line with national priorities. 18 Bank Rate is the rate of interest at which the Reserve Bank is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase under the RBI Act,1934.With raising or lowering of the Bank Rate, the cost of borrowing from the RBI for the banks becomes dearer or cheaper. 19 Reserve Bank of India, “Chronology of Events: Social Controls, the Nationalisation of Banks and the era of bank expansion - 1968 to 1985”, http://www.rbi.org.in 20 Glimpses of RBI’s history”, http://www.bankbazaar.com, January 21, 2010 21 The final objective of a monetary targeting policy was price stability. Under monetary targeting, the central bank intervenes in the money market. 22 “Analytics of Monetary Policy in India since independence”, http://shodhganga.inflibnet.ac.in 23 “Analytics of Monetary Policy in India since independence”, http://shodhganga.inflibnet.ac.in 24 “Report Of The Working Group On Operating Procedure Of Monetary Policy”, http://rbidocs.rbi.org.in, March 2011

In 1991, there was an external payment crisis, due to which the rupee was devalued in two stages. The cumulative devaluation was about 18% in USD terms.25 In 1991, the Narasimham Committee recommended a wave of financial sector reforms in the country. The deregulation of interest rates, which started in the early 1990’s, was completed by October 1997.26 The Narasimham Committee pointed out that a high Cash Reserve Ratio (CRR) adversely affected the profitability of banks, as it exerted pressure on them to charge high interest rates on their commercial sector advances.27 As a result, CRR as a tool of monetary control was de-emphasized and liquidity management was undertaken by Open Market Operations (OMOs)28. Another major reform was carried out in the year 1997 under the leadership of C. Rangarajan (Rangarajan), RBI governor from 1992-1997.Rangarajancame out forcefully in favor of procuring greater autonomy for the RBI. This paved the way for the signing of a historic memorandum between the RBI and the Government, whereby a cap was put on the automatic finance by the RBI to the Government in the form of ad hoc treasury bills.29 This measure resulted in the elimination of the automatic monetization of government deficits and moderated the monetized deficit in the late nineties.30 Simultaneously, the opening up of the economy and the development of financial markets endowed the RBI with considerable instrument independence to achieve the monetary policy objectives. Finally in April 2006, the phasing out of the participation by the RBI in the primary auction of government securities enabled the central bank to conduct monetary policy operations using a market-based model.31 In June 2000, the Liquidity Adjustment Facility (LAF)32 was introduced as a tool to modulate short-term liquidity and signaling of interest rates in the overnight market. As of 2012, LAF had emerged as the key element of the monetary policy, as it helped in steering the desired trajectory of interest rates in response to evolving market conditions.

RBI GOVERNORS: 1997-2013

Out of all the RBI governors, Bimal Jalan (1997-2003), stood tall for his crisis management skills. Jalan became the RBI governor in November 1997, when the Asian financial crisis was at its peak. A series of problems like the US sanctions, the Kargil War, an oil crisis, and the US invasion of Iraq followed, and Jalan brought in sweeping reforms. The Financial Express, highlighting the large number of Jalan’s achievements during his tenure as governor, said, “The external sector management, the control of inflation, the strengthening of the banking system, internal debt management, regulation and supervision, currency management and internal reforms on HRD were all handled with sagacity, élan and style.”33 According to the RBI, Jalan’s tenure was

25 Reserve Bank of India, “Crisis and Reforms: 1991 to 2000”, http://www.rbi.org.in 26 “Report Of The Working Group On Operating Procedure Of Monetary Policy”, http://rbidocs.rbi.org.in, March 2011 27 “Analytics of Monetary Policy in India since independence”, http://shodhganga.inflibnet.ac.in 28 OMO is an activity by a central bank to buy or sell government bonds on the open market. 29 Reserve Bank of India, “ Reserve Bank of India History: Governors”, http://rbi.org.inl 30 Y.V. Reddy, “Monetary and Financial Sector Reforms in India: A Practitioner's Perspective”, http://www.economics.cornell 31 Report Of The Working Group On Operating Procedure Of Monetary Policy”, http://rbidocs.rbi.org.in, March 2011 32 LAF enables banks to mitigate their short-term mismatches in cash management on a daily basis with the RBI. LAF operates through repo and reverse repo auctions, thereby setting a corridor for the short-term interest rate consistent with policy objectives. 33 “Select Press Comments On Demitting Office As Governor, RBI”, http://www.bimaljalan.com/farewell.html

Licensed for use in the Case Writing Workshop at Bapuji B - Schools, Davangere on March 16, 2019. Faculty Nqame: Prof. G V Muralidhara. Imperatives for Reserve Bank of India – Agenda for Raghuram Rajan characterized by the strengthening of the balance of payments and forex position, low inflation, and soft interest rates (Refer to Exhibit I for the relative performance of India’s recent four RBI governors). Y. V. Reddy (Reddy), RBI governor from 2003 to 2008, took charge in relatively more stable times. During his tenure, Reddy understood the risk of global imbalances and mispricing of risks in the global markets. As a result, he maintained a tight monetary policy stance throughout his tenure.34 Unlike Rangrajan and Jalan35, who shared a good relationship with the government, Reddy did not enjoy a cordial relationship with P Chidambaram (Chidambaram), India’s finance minister. Reddy did not agree with Chidambaram on financial sector reform, especially on liberalizing the capital account in haste.36 Reddy also disagreed with him on interest rates, increasing the interest rates to cool down an overheated economy, whereas Chidambaram favored low interest rates to promote economic growth. Dr. Duvvuri Subbarao (Subbarao), the 22nd RBI Governor (September 2008-2013), assumed responsibility when the global financial system had almost collapsed into the deepest economic crisis since the Great Depression. Subbarao too shared an uneasy relationship with the finance ministry over the RBI’s tight monetary policy. Chidambaram was unhappy with the fact that the RBI under Subbarao’s leadership decided to keep the interest rates high, despite the government unveiling a five-year fiscal consolidation map.37 Subbarao did not heed his advice to reduce the interest rates. Chidambaram criticizing his stance, said in October 2012, “Growth is as much a challenge as inflation. If the government has to walk alone to face the challenge of growth, then we will walk alone.”38 On August 29, 2013, in his farewell speech, Subbarao remarked that with no clear mandate set out in the RBI Act, the government blamed the RBI and its monetary policy for all the economic problems, especially the slow economic growth and the rupee depreciation during 2012-2013.39 He said the moderation in India’s economic growth to 5% in the fiscal year 2012-2013 from 6.5% in 2011-2012, was due to a host of supply-side constraints and governance issues, and not to the RBI’s tight monetary policy.40 According to Subbarao, the widening current account deficit, which resulted in the rupee decline in 2013, was to be blamed on the government.41 Chidambaram himself was of the view that policy decisions taken by the government during 2009-2011 had contributed to the swelling of the current account deficit.42 Subbarao during his tenure did not give into the pressures of the government by reducing the interest rates. In his final speech, he hoped

34 K. Kanagasabapathy, “When RBI chiefs speak their mind”, http://www.thehindubusinessline.com, August 19, 2011 35 Rangarajan shared a mutual relationship with the then finance minister Manmohan Singh. In 1991, the reforms carried out by Ranagrajan complemented the financial reforms. Jalan also shared a cordial relationship with the finance ministry, especially with the then finance minister, Yashwant Sinha. 36 Niranjan Rajadhyaksha, “Trial by fire awaits Raghuram Rajan as RBI governor”, http://www.livemint.com, August 06, 2013 37 Anand Adhikari ,“His own man”, http://businesstoday.intoday.in, November 24, 2013 38 Ashok Dasgupta, “We will ‘walk alone’ if need be: Chidambaram”, http://www.thehindu.com, October 31, 2012 39 “RBI boss delivers a parting kick:Finger at loose Govt stance”, http://www.telegraphindia.com, August 30, 2013 40 “RBI boss delivers a parting kick: Finger at loose Govt stance”, http://www.telegraphindia.com, August 30, 2013 41 “Subbarao’s parting shot to Chiddu: Don’t blame RBI for rupee’s worries”, http://www.firstpost.com, August 30, 2013 42 Subbarao’s parting shot to Chiddu: Don’t blame RBI for rupee’s worries”, http://www.firstpost.com, August 30, 2013

Licensed for use in the Case Writing Workshop at Bapuji B - Schools, Davangere on March 16, 2019. Faculty Nqame: Prof. G V Muralidhara. Imperatives for Reserve Bank of India – Agenda for Raghuram Rajan that one day the finance minister would recognize that the RBI’s actions were correct. He said “I do hope Finance Minister Chidambaram will one day say, 'I am often frustrated by the Reserve Bank, so frustrated that I want to go for a walk, even if I have to walk alone. But thank God, the Reserve Bank exists.”43

AGENDA FOR RAGHURAM RAJAN

Raghuram Rajan, appointed as the 23rd governor of the RBI on September 4, 2013, for a tenure of three years, had a remarkable background. Analysts felt this would help him manage the Indian economy, which was at its lowest point since 1991. Rajan became the youngest-ever chief economist at the IMF at the age of 40 and served there during 2003-2006. Rajan was one of the few economists who predicted the 2008 financial crisis correctly. In 2012, he was appointed as Chief Economic Adviser to India’s Finance Ministry. He was known as an economist with a rockstar appeal and was among the top 10 economists of the world in 2012. As soon as Rajan became RBI governor, he took many steps to stop the rupee’s fall. In early September 2013, when foreign fund inflow slowed down, Rajan opened a swap window for deposits from non-resident Indians. In a matter of two months, the swap window had attracted USD12 billion.44 Rajan also allowed banks to borrow more overseas. Apart from this, external factors like the easing worries of a US strike on Syria and Ben Bernanke’s45 decision to postpone the tapering of its US$85 billion a month bond-buying program on September 18, 2013, aided in the stabilization of the rupee. After Bernake’s announcement, the Indian rupee appreciated by 2.5% to INR61.7 against the dollar46 (Refer Exhibit to II for Rajan’s main initiatives in the first 60 days of his office). Apart from stemming the rupee fall, banking sector reform was also high on Rajan’s list of priorities (Refer to Exhibit III for measures taken by the RBI). Rajan opined that “changing the financial sector will help India to grow.”47

STUBBORN INFLATION

In the first two months, Rajan raised the central bank’s main lending rate twice to control inflation. This was despite knowing that the government preferred a reduction in interest rates to boost the economy. The RBI’s repo rate, the rate at which the RBI lent money to banks, was raised for the second time on October 29, 2013 to 7.75%.48 This move came after October 2013’s CPI inflation stood at a worrying 10.9%, WPI inflation at 7%, and food inflation at an alarming 18.9%. 49 According to analysts, Rajan was following in the steps of Subbarao,50 who had raised the repo rate a record 13 times – from 4.75% to 8.5% during March 2010 and October 2011.51

43 “D Subbarao: P. Chidambaram will one day say 'thank God RBI exists”, http://www.indianexpress.com, August 29, 2013 44 http://in.finance.yahoo.com/news/rajan-quietly-asserted-autonomy-rbi-184100774.html 45 US Federal Reserve Chairman in 2013 46 “India must get out of its policy taper: ET Jury”, http://economictimes.indiatimes.com, September 20 2013 47 http://www.hindustantimes.com/business-news/businessbankinginsurance/the-rajan-effect-rupee-rises- again/article1-1136124.aspx 48 “RBI raises repo rate, cuts MSF”, http://in.reuters.com, October 29, 2013 49 Remya Nair, “WPI inflation rises to 7% in Oct, adding pressure on RBI”, http://www.livemint.com, November 14, 2013 50 “Chidambaram, Rajan: Agree to disagree?”, http://businesseconomics.in, 2013 51 Anand Adhikari , “His own man”, http://businesstoday.intoday.in, November 24 2013

Some economists opined that the rate hikes had slowed down the country’s growth but not the inflation, which remained stubborn (Refer to Exhibit IV to understand the relationship between repo rate, GDP growth and inflation). Chidambaram, criticizing the move, said, “Monetary policy has no impact on food prices…the only way we can contain food inflation is to augment supplies, but supplies are not entirely elastic…For supplies to rise we need great investment, great production, better distribution, and better logistics.”52 However, defending the interest rate hike, Rajan opined “…CPI is at a worrisome number at 10% and beyond. I do not think there is any elbow room to give any kind of relaxation as far as interest rates are concerned.”53 Rangarajan, former RBI governor, who had also focused on price stability during his tenure (1992-1997), said there was always a dilemma between growth and inflation. He said, “People were critical of me, but I broke inflation's back. I took the position that we have to increase interest rates.”54

WIDENING CURRENT ACCOUNT DEFICIT

According to the RBI, India’s widening current account deficit, which was the main reason for the rupee’s decline, was estimated to come down to USD56 billion (3% of the GDP) for the fiscal year 2013-2014, when compared to a deficit of USD88 billion (4.8% of the GDP) in 2012-2012.55 The decline in gold imports was expected to narrow the current account deficit, and as a result, according to Rajan, there was no fundamental reason for the rupee’s decline.56 However, analysts opined that India which imported79% of its oil imports,57 would continue to face a high current account deficit, and, as a result, the rupee was likely to continue weakening over the long term. According to a report by Wharton, in the fiscal year 2012-2013, India’s oil imports were 2.6 million barrels per day (bpd), which pushed its oil import bill to USD109 billion. This was the major cause behind India’s huge current account deficit of USD88 billion.58 The gold import bill for the same year stood at USD47 billion, less than half of India’s oil import bill. The Wharton report opined that unless the Indian government took drastic steps59 to reduce its oil imports, “the weakness or strength of the Indian rupee will continue to be largely determined by the level and costs of the country’s crude oil imports.”60

52 “India and the slowing economy: Chidambaram squares off RBI, again!”, http://articles.economictimes.indiatimes.com, November 16, 2013 53 “India and the slowing economy: Chidambaram squares off RBI, again!”, http://articles.economictimes.indiatimes.com, November 16, 2013 54 “Anand Adhikari”, “Rajan has quietly asserted his autonomy as RBI chief”, http://in.finance.yahoo.com, November 06 2013 55 “Rajan pegs CAD at 56 billion, says no reason for R decline”, http://www.indianexpress.com, November 14, 2013 56 “Rajan pegs current account deficit at $56 billion this year, says no reason for rupee decline”, http://timesofindia.indiatimes.com, November 13, 2013 57 “Nearly 80 per cent of India's crude oil needs to be imported: VeerappaMoily”, http://businesstoday.intoday.in, August 27, 2013 58 “The Future of the Indian Rupee Is Tied to Oil Imports”, https://knowledge.wharton.upenn.edu, November 15, 2013 59 The Indian government needed to reduce its oil subsidies (USD25 billion a year), and there was also a need for punitive taxes to curb use of petroleum products, as was the case in some European countries. But both were unlikely to happen given the political backlash from the beneficiaries of the subsidies as well as automakers, distributors, and service providers, and employee unions in the auto industry. 60 “The Future of the Indian Rupee Is Tied to Oil Imports”, https://knowledge.wharton.upenn.edu, November 15, 2013

RBI: THE SAVIOR OF INDIA’S ECONOMY?

There were a lot of expectations that Rajan would tackle the most serious economic problems in more than two decades. However, according to Rajan, a central bank governor could only affect access to finance.61 In this regard, he devised five pillars of financial reform which were: clarifying and strengthening the monetary policy framework; reforming the banking system; liberalizing Indian markets; increasing financial inclusion; and sorting out financially distressed financial institutions.62 Rajan’s five pillars were compared to Abenomics, the term coined for Japanese Prime Minister Shinzo Abe’s (Abe) economic policies. In December 2012, Abe, to stimulate Japan’s economic growth and to escape from 15 years of deflation, came up with a macroeconomic policy comprising three pillars: bold monetary easing; flexible fiscal policy; and a growth strategy.63 According to some analysts, Rajan’s five pillars lacked the deep, broad-ranging structural reforms that comprised the third pillar of Abenomics, which was expected to have the most lasting impact.64 In August 2013, Abe’s and Bank of Japan’s gamble on massive fiscal and monetary stimulus had started to pay off, and Japan was slowly escaping from deflation, with rising prices, falling unemployment, higher incomes, and factory activity.65 Rajan acknowledged that there was a limit to what central bankers could do.66 A central bank could only manage a state's currency, money supply, and interest rates; it did not have the potential to address the lagging structural problems that had affected India's development since 1947.67 According to analysts, “The central bank governor can't sort out the trade deficit, the fiscal deficit, or the lagging education system. These are among the persistent issues that have plagued India's growth.”68 The biggest challenge before Rajan was not to get labeled as India’s savior, because “the country’s economic future was largely in the hands of its government, not its central bank.”69 Analysts were hoping that Rajan could push the Finance Minister and Prime Minister of India to adopt better policies and at the same time maintain the autonomy of the RBI.70

61 Linda Yueh, “The Limits of Star Power”, http://www.bbc.co.uk, October 29, 2013 62 ShefaliAnand, “The Five Pillars of RaghuramRajan”, http://blogs.wsj.com, October 24, 2013 63 Kozo Koide , “Abenomics”, http://www.diam.co.jp, February 23, 2013 64 Linda Yueh, “The Limits of Star Power”, http://www.bbc.co.uk, October 29, 2013 65 Leika Kihara and Tetsushi Kajimoto, “More Signs Abenomics is Working as Japan Prices, Output Rise”, http://uk.reuters.com, August 30,2013 66 Sachin Kumar, “The Rajan Effect: Rupee Rises Again”, http://www.hindustantimes.com, October 16, 2013 67 Linda Yueh, “The Limits of Star Power”, http://www.bbc.co.uk, October 29, 2013 68 Linda Yueh, “The Limits of Star Power”, http://www.bbc.co.uk, October 29, 2013 69 “Into the pressure cooker”, http://www.economist.com, September 07, 2013 70 “Into the pressure cooker”, http://www.economist.com, September 07, 2013

Exhibit I Performance of RBI Governors during Their Tenures C. Rangarajan Bimal Jalan Y.V. Reddy D. Subbarao (December 1992- (November (September (September 1997) 1997-2003) 2003-2008) 2008-2013) Average 7.79% 4.53% 5.85% 7.23% Inflation GDP 5.49% 5.4% 7.9% 7.86% Growth Exchange -9.16% -5.67% -0.68% -8.35% rate * *Annualized rupee depreciation against the dollar Adapted from Niranjan Rajadhyaksha , “Trial by fire awaits Raghuram Rajan as RBI governor”, http://www.livemint.com, August 06, 2013

Exhibit II Raghuram Rajan’s Main Initiatives (First 60 days)

 Reduced short-term interest rates by withdrawing earlier exceptional measure to reduce forex volatility.  Completely freed branch licensing.  Talked about permitting foreign banks to acquire local lenders with riders.  Attracted USD12 billion via swap facility of dollar deposits.  Relaxed forex hedging limits for exporters/ importers to rebook cancelled forward contracts. Adapted from Anand Adhikari ,“His own man”, http://businesstoday.intoday.in, November 24, 2013

Exhibit III RBI’s Measures Measures For Banks, Non-Bank Financial Companies  Foreign banks setting up wholly-owned subsidiaries to be given near-national treatment. The RBI to issue this scheme by mid-November 2013.  Initial minimum paid-up voting equity capital or net worth for wholly owned foreign bank's subsidiary to be USD5 billion.  More durable way for banks to mitigate mismatch in demand and supply of cash is to step up efforts to mobilize deposits.  Draft report on Basel III capital framework likely by November-end 2013.  Draft of proposed framework for domestic systemically important banks by November-end 2013.  The RBI to issue updated guidelines on stress testing for banks by November-end 2013.  Banks to be given the option to pay interest on savings deposits and term deposits at intervals shorter than quarterly intervals.  First meeting of High Level Advisory Committee on new bank licenses was on November 1 2013.  Guidelines on restructuring for non-bank finance companies (NBFCs) to be issued by November-end 2013. Measures For Markets, Liquidity  To issue 10-year retail inflation-indexed securities in November/December 2013.  To launch 10-year interest rate futures contracts by end-December 2013.  To allow partial credit enhancement for corporate bonds by banks via credit, liquidity facilities  To issue final guidelines on unhedged foreign currency exposures by end-December 2013.  To close special repo window for mutual funds with immediate effect. Adapted from “RBI raises repo rate, cuts MSF”, http://in.reuters.com , October 29, 2013

Exhibit IV India’s Stubborn Inflation (2002-03 to 2012-13)

Adapted from AnandAdhikari , “His own man”, http://businesstoday.intoday.in, November 24 2013