The country’s chief money man needs different skills

When Duvvuri Subbarao took over as Reserve Bank governor around this time last year, he probably didn’t know what would hit him. He came in a firesuit, assuming he had to fight inflation, raging at over 12%. But within a month he had to abandon his firesuit for warm woollies, for he was facing the equivalent of a nuclear winter: a potential global depression brought on by global financial collapse and loss of confidence in the system.

He quickly reversed course and launched some of the most dramatic rate cuts in Indian monetary history — between October, 2008, and January, 2009, the cash reserve ratio, which  money bankers have to keep locked up with the Reserve Bank for little or no returns — was brought down from 9% to 5%, releasing a flood of cheap money in the system (as much as Rs 1,60,000 crore).

But that was the easy part. Politicians love cheap money, and cutting rates was both sensible monetary policy and good populism. Today, Subbarao faces a tougher challenge. The threat of deflation is gone, and inflation is likely to rear its ugly head once again, thanks to uncomfortably high food prices and excessive government spending. Will Subbarao rise to the challenge?

He has every skill needed for the job. An IITian and IAS topper who learnt his economics in the US, his academic-intellectual capacities are in no doubt. He does not claim to be a know-all and has an open mind on issues. Like any bureaucrat, he is cautious, and that’s an asset. Caution and circumspection is not a bad thing in a central banker.

The reason why I have elaborated at some length on Subbarao’s credentials is simple: an ordinary economist will not do for the job. The world economy has grown so complex that it is no longer possible to forecast anything about its future direction with any precision. In July last, the world economy looked a bit woozy, but not completely sick. Two months later, we landed in the worst possible crisis since 1929.

Even hindsight does not offer us much insight. We know that the decision to let Lehman Brothers go bust precipitated the financial collapse. But what if Lehman had been bailed out? Would it have been business as usual? The jury is still out on that. It may just have postponed the day of reckoning. But we will never know.

Take our own scenario. A year ago, we were battling inflation. Six months back, we were feverishly trying to avoid becoming victims of the global recession. Now we are back to inflation. In the first half of 2008, the economy was growing like gangbusters. In the second half, it slowed to a crawl. Now is revving up, but faces the prospect of rising interest rates. No one can predict whether we will have 5% inflation and 6.5% growth, or 6.5% inflation and 5.5% growth by March, 2010. 

There are so many variables impacting the real economy — currency speculation, asset prices (stocks, real estate), inflationary expectations, and political and systemic issues — that it is not possible for a mere economist to read the signals right. Put another way, the Reserve Bank governor’s role is no longer to manage inflation, or growth or currency or interest rates, but to manage the overall risk. He has to be a behavioural scientist as well, for he has to judge how people — from market players, to bankers, to companies and individuals — will respond to the current mix of economic trends, market expectations and policy givens.

The previous US Federal Reserve governor, Alan Greenspan, once widely lauded for his ability to steer monetary policy towards the right goals, is now seen as having failed in many ways. For one, he allowed the stock markets to boom too much. For another, he failed to see the risk in allowing excessive speculation in financial instruments like collateralised debt obligations (CDOs). Such was the faith in Greenspan’s abilities, that the markets started believing he was superman, under whom no harm can come to the economy.

They were wrong. Greenspan was merely setting the US economy up for a fall. The lesson for Subbarao is this: his training as an economist may suggest that when the wholesale prices index is near zero, inflation is not an immediate worry. But the money markets, bankers, borrowers and punters are not looking at past data. Subbarao may find that he has to squelch inflationary expectations sooner rather than later. Fires must be put out before they spread. nnn