I Do What I Do

by Raghuram G. Rajan

This was not my first job in management. But I became head of an organization of 17,000 people, with assets of more than $400 billion. How does one manage such a large organization? Obviously with help. I have always found that the single most important task in management is to pick good deputies, and I managed to get very good ones.

India is becoming a large middle income country, too complex and varied to be controlled centrally. The government will need to withdraw from occupying the commanding heights of the economy, confining itself to providing public goods and the governing framework, and leaving economic activity to the people. To harness their collective energy, India will need many such reforms in the years to come if it is to grow rapidly in a sustainable and equitable way.

The job of Governor is probably the most fulfilling job any Indian economist could aspire for. There were many days when I went home tired but happy that we had really made a difference. There are very few jobs in public administration where one can say this because one is always hemmed in by the need to get the concurrence of other organizations, and turf battles make it hard to move forward. At the RBI, on many issues the decision was ours, and ours alone, so progress was feasible and continuous. This also meant that the job weighed constantly on my mind, for I had to keep asking what more we could do, given the possibilities were endless. Putting a policy economist in the Governor’s job is like letting a kid loose in a candy shop!

while some bureaucrats were a delight to work with, the least pleasant aspect of my job was dealing with bureaucrats who were trying to undercut the Reserve Bank so as to expand their turf. In my last speech as Governor (see later), I offered suggestions to the government on how to reduce these unproductive frictions.

Any public job involves both undue praise and unfair criticism. It is human nature to think the latter dominates the former. Yet it is also the latter that is probably more useful in helping you sharpen your message.

In August, at the annual Lalit Doshi memorial lecture, Rajan said, ‘I am not quite sure if what you meant is demonetise the old notes and introduce new notes instead. In the past, demonetisation has been thought of as a way of getting black money out of circulation. Because people then have to come and say ‘how do I have this 10 crores in cash sitting in my safe and they have to explain where they got the money from. It is often cited as a solution. Unfortunately, my sense is, the clever find ways around it.’ Rajan said, ‘Black money hoarders find ways to divide their hoard into many smaller pieces. You find that people who haven’t thought of a way to convert black to white, throw it into the hundi in some temples. I think there are ways around demonetisation. It is not that easy to flush out the black money.’

I was asked by the government in February 2016 for my views on demonetization, which I gave orally. Although there might be long-term benefits, I felt the likely short-term economic costs would outweigh them, and felt there were potentially better alternatives to achieve the main goals. I made these views known in no uncertain terms. I was then asked to prepare a note, which the RBI put together and handed to the government. It outlined the potential costs and benefits of demonetization, as well as alternatives that could achieve similar aims. If the government, on weighing the pros and cons, still decided to go ahead with demonetization, the note outlined the preparation that would be needed, and the time that preparation would take. The RBI flagged what would happen if preparation was inadequate.

I took over as the 23rd Governor of the Reserve Bank of India on 4 September 2013. The rupee had been in free fall in August, inflation and the current account deficit were high. Even though Mr Chidambaram, who had been brought back as Finance Minister in 2012 when Mr Pranab Mukherjee became the President of India, had taken an axe to the fiscal deficit, it was still large. With elections looming in May 2014, and the possibility of a hung parliament, investors were getting nervous.

I talked about the primary role of the RBI as preserving the purchasing power of the rupee, but we have two other important mandates; inclusive growth and development, as well as financial stability.

The Indian public would benefit from more competition between banks, and banks would benefit from more freedom in decision making. The RBI will shortly issue the necessary circular to completely free bank branching for domestic scheduled commercial banks in every part of the country. No longer will a well-run scheduled domestic commercial bank have to approach the RBI for permission to open a branch. We will, of course, require banks to fulfil certain inclusion criteria in underserved areas in proportion to their expansion in urban areas, and we will restrain improperly managed banks from expanding until they convince supervisors of their stability. But branching will be free for all scheduled domestic commercial banks except the poorly managed.

On the retail side, I particularly want to emphasize the use of the unique identity, Aadhaar, in building individual credit histories. This will be the foundation of a revolution in retail credit.

This is part of my short-term time table for the Reserve Bank. It involves considerable change, and change is risky. But as India develops, not changing is even riskier. We have to keep what is good about our system, of which there is a tremendous amount, even while acting differently where warranted. The RBI has always changed when needed, not following the latest fad, but doing what is necessary. I intend to work with my excellent colleagues at the Reserve Bank, the senior management of which is represented around this table, to achieve the change we need.

If you can trust yourself when all men doubt you, But make allowance for their doubting too:

Policy making is about deciding in the face of uncertainty, after weighing the alternatives as best as one can.

Autobiographies are always written as if the author had it all mapped out with perfect foresight, ignoring the risks and uncertainties at that time.

Policy making invariably involves taking measured risks in the face of uncertainty, for one has neither a prior template nor the luxury of indecision.

We can spend a long time debating the sources of this inflation. But ultimately, inflation comes from demand exceeding supply, and it can be curtailed only by bringing both in balance. We need to reduce demand somewhat without having serious adverse effects on investment and supply. This is a balancing act, which requires the Reserve Bank to act firmly so that the economy is disinflating, even while allowing the weak economy more time than one would normally allow for it to reach a comfortable level of inflation. The weak state of the economy, as well as the good kharif and rabi harvest, will generate disinflationary forces that will help, and we await data to see how these forces are playing out. No single data point or number will determine our next move.

There are a number of points here that need elaborating. First, are we choosing to tackle inflation at the expense of growth? Most people believe there is a short-run trade-off between growth and inflation. By raising interest rates, the RBI causes banks to raise rates and thus lowers demand; firms do not borrow as much to invest when rates are higher and individuals stop buying durable goods against credit and, instead, turn to save. Lower demand growth leads to a better match between demand and supply, and thus lower inflation for the goods being produced. Relatedly, if lower rates generate higher demand and higher prices for goods, people may produce more of those goods, believing that they are getting more revenues. But because all goods are going up in price, high inflation reduces what they can buy out of the revenues. Following the saying, ‘You can fool all the people some of the time’, bursts of inflation can generate growth for some time. Thus, in the short run, the argument goes, higher inflation leads to higher growth.

The typical letter I get (from the retiree) goes, ‘I used to get 10 per cent earlier on a one-year fixed deposit, now I barely get 8 per cent’, please tell banks to pay me more else I won’t be able to make ends meet’. The truth is that the retiree is getting more today but he does not realize it, because he is focusing only on the nominal interest he gets and not on the underlying inflation which has come down even more sharply, from about 10 per cent to 5.5 per cent. To see this, let us indulge in Dosa economics. Say the pensioner wants to buy dosas and at the beginning of the period, they cost Rs 50 per dosa. Let us say he has savings of Rs 1,00,000. He could buy 2,000 dosas with the money today, but he wants more by investing. At 10 per cent interest, he gets Rs 10,000 after one year plus his principal. With dosas having gone up by 10 per cent in price to Rs 55, he can buy 182 dosas approximately with the Rs 10,000 interest. Now what happens when inflation comes down? At 8 per cent interest, he gets Rs 8,000 in interest. With dosas having gone up by 5.5 per cent in price, each dosa costs Rs 52.75, so he can now buy only 152 dosas approximately with the interest payment. So the pensioner seems right to complain: with lower interest payments, he can now buy less. But wait a minute. Remember, he gets his principal back also and that too has to be adjusted for inflation. In the high inflation period, it was worth 1,818 dosas, in the low inflation period, it is worth 1,896 d...

This is a long-winded way of saying that inflation is the silent killer because it eats into pensioners’ principal, even while they are deluded by high nominal interest rates into thinking they are getting an adequate return. Indeed, with 10 per cent return and 10 per cent inflation, the deposit is not giving you any real return net of inflation, which is why you can buy only 2,000 dosas after a year of saving, the same as you could buy immediately today. In contrast, when inflation is 5.5 per cent but the interest rate you are getting is 8 per cent, you are earning a real rate of 2.5 per cent, which means 2.5 per cent more dosas, as we have seen. So while I sympathize with pensioners, they certainly are better off today than in the past.

CPI inflation was 4.39 per cent in September 2016 when I ended my term, down from 10.5 per cent in September 2013 in the beginning of my term.* We were well on our way to meeting the third signpost on our glide path, 5 per cent inflation by March 2017 (which was indeed achieved by my successor). As I ended my tenure, I thought it was very important to communicate once again the reasons why we fought inflation, and why the battle could never be fully over, and why the fight needed to continue.

High inflation has been with us in India for the last four decades. Most recently, we have experienced an average of more than 9 per cent inflation between 2006 and 2013. What are the costs of having high inflation? Clearly, everyone understands the costs of hyperinflation, when prices are rising every minute. Money is then a hot potato that no one wants to hold, with people rushing straight from the bank to the shops to buy goods in case their money loses value along the way.

These effects kick in only when inflation is noticeably high. So it is legitimate to ask, ‘At what threshold level of inflation does it start hurting growth?’ Unfortunately, this question is hard to answer – developing countries typically have higher inflation, and developing countries also have higher growth. So one might well find a positive correlation between inflation and growth, though this does not mean more inflation causes more growth. For this reason, the literature on estimating threshold effects beyond which inflation hurts growth is both vast as well as inconclusive. Most studies find that double-digit inflation is harmful for growth but are fuzzier about where in the single digits the precise threshold lies.

Far too many loans are done without adequate due diligence and without adequate follow up. Collateral when offered is not perfected, assets given under personal guarantees not tracked, and post-loan monitoring of the account can be lax. The lessons of the recent past should be taken seriously, and management practices tightened. A more stringent approach to evaluating and recovering large loans will give bank management the credibility when they go to their staff with plans for cost rationalization.

The middle-management ranks of public sector banks are being thinned by retirements. In addition, they need experts in specific areas like project evaluation and risk management. At the same time, banks have to reduce bloated cost structures. All public sector entities across the world tend to pay more than the private sector to lower level employees, and less than the private sector to higher level employees. This makes it hard for them to attract top talent, but makes it easier to attract good people at lower levels.

One of the difficulties public sector banks have is court judgments that prohibit hiring from specific campuses. This leads to anomalies like the public-sector-bank-supported National Institute of Bank Management sending most of its high quality graduates to work for private sector banks. Public sector banks can petition the courts to allow some modicum of campus hire, especially when the campus chooses openly through a national exam. Another alternative is to make bank entrance exams much less onerous to take, with applications, tests, and results, wherever possible, available quickly and online. The banks then have an easier task of persuading students on elite campuses to take the exam. We are following this latter course at the RBI.

Today, a variety of authorities – Parliament, the Department of Financial Services, the Bank Board Bureau, the board of the bank, the vigilance authorities, and of course various regulators and supervisors including the RBI – monitor the performance of the public sector banks. With so many overlapping constituencies to satisfy, it is a wonder that bank management has time to devote to the management of the bank. It is important that we streamline and reduce the overlaps between the jurisdictions of the authorities, and specify clear triggers or situations where one authority’s oversight is invoked.

With changes in technology, cyber security, both at the bank level and at the system level, has become very important. I think it would be overly complacent for anyone of us to say we are well prepared to meet all cyber threats. A chilling statement by an IT expert is ‘We have all been hacked, the only question is whether you know it or you don’t’. While the statement may be alarmist, it is an antidote to complacency. We all have to examine our security culture. Too many access points are left unmonitored, too many people share passwords or have easily penetrated passwords, too little surveillance is maintained of vendors and the software they create. The RBI is working on upgrading the capabilities of its inspectors to undertake bank system audit as well as to detect vulnerabilities in them. The RBI is also in the process of setting up an IT subsidiary, which will be able to recruit directly from industry, and will give the Reserve Bank better ability to manage and supervise technology. I would urge all of you to take a fresh look at your systems, and more important, of the cyber culture within your bank.

Last week, I met with some members of Ela Bhatt’s Self-Employed Women’s Association. In a room full of poor but confident women entrepreneurs, I asked how many borrowed from moneylenders before they came to SEWA. About half the women raised their hands. When asked how many thought of approaching a regular bank before they came to SEWA’s cooperative bank, not one raised her hand. Interestingly, many of them said that the loan from SEWA freed them from the moneylender’s high interest rate, which gave them enough to service SEWA’s loan fully even while focusing on other productive activities. I have heard this from other micro-entrepreneurs – the highest return initial investment is often to free oneself of the clutches of the moneylender. Despite this high return from the delivery of credit to the poor, and despite much of our financial inclusion efforts being focused on credit, we still reach too few of the target population. So there is much more to be achieved.

The broader issue is whether through sophisticated state-of-the-art technology, we can offer customers products that are simple, low cost, and easy to use. We have done this with mobile phones, can we do it with banking? Payments may be another obvious product. I should note that our payments infrastructure in India is very advanced. We have three large RBI technology centres devoted to supporting payments and robust payment and settlement networks for both large value and small transactions. We have introduced an additional factor of authentication for all e-commerce transactions – which makes these transactions more secure – and are swiftly moving to Chip and PIN technology for credit card transactions. SMS alerts for bank and credit card transactions are an important advance relative to even the United States, where thieves find it easy to bill thousands of dollars to your credit card even before you know it is stolen. All this means that we have the infrastructure to provide cheap and safe payments and remittances. What we need are non-governmental players to utilize this infrastructure to provide the products and access that people want.

One of the primary motivations for the country to push financial inclusion is to free the excluded from the clutches of the moneylender. How does the moneylender boldly lend where no banker dares to lend? Because he does not suffer the same impediments! Coming from the local community, the sahukar is well informed on what everyone’s sources of income and wealth are, and how much they can repay. He is quite capable of using ruthless methods to enforce repayment. Moreover, the borrower knows that if he defaults on the sahukar, he loses his lender of last resort. So the borrower has strong incentives to pay. Finally, because the sahukar lives nearby and uses minimal documentation – after all, he is not going to use the courts to force repayment – loans are easily and quickly obtained. In an emergency or if the poor need to borrow on a daily basis, there are few more readily available alternatives than the moneylender. No wonder he has so many in his clutches.

As I argued earlier, the moneylender is particularly effective because he knows the neighbourhood and its people, and can make a good assessment of who is creditworthy. A large national bank with a local branch suffers from two infirmities. First, the branch manager has typically been recruited through an all-India exam, is from a different state, and is not intimately familiar with the local people. While many good branch managers do indeed learn about the community, some do not. The higher socio-economic status of bank officers also creates a distance with the poorer segments of the community, and their high salary makes many branches in remote areas economically unviable even if they could solicit business intelligently. Finally, given that the excluded do not have formal documents, bank managers in large banks with bureaucratic centralized procedures find it hard to provide effective service – how does one convey to head office the rationale for a loan to an intelligent, enthusiastic tribal who wants to set up a small shop, but who has no formal education or track record?

However, even though a system that allows for strong enforcement of repayment reduces the credit risk margin lenders charge, it also imposes larger costs on unfortunate borrowers. So, for example, should a student who chose the wrong college for studies and ended up having to pay back huge loans with only a mediocre job be penalized for life? We need a system that has some flexibility in repayment, so that those who make bad choices or have bad luck can get some relief. At the same time, they should not escape all responsibility, else we will see people borrowing excessively and misusing the proceeds, knowing they can get away scot-free.

when a large borrower defaults, he is contrite and desperate to show that the lender should continue to trust him with management of the enterprise. In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken – the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back! No wonder government ministers worry about a country where we have many sick companies but no ‘sick’ promoters.

For think of a mediaeval businessman who knows he will be imprisoned or even beheaded if he defaults. What incentive will he have to engage in innovative but risky business? Is it any wonder that business was very conservative then? Indeed, Viral Acharya of NYU and Krishnamurthi Subramanian of ISB show in a compelling study that innovation is lower in countries with much stricter creditor rights. Or put differently, the solution to our current problems is not to make the laws even more draconian but to see how we can get more equitable and efficiency-enhancing sharing of losses on default.

These data refute another argument made by those who do not look at the evidence – that stress in the corporate world is because of high interest rates. Interest rates set by private banks are usually equal or higher than rates set by public sector banks. Yet their credit growth does not seem to have suffered. The logical conclusion therefore must be that it is not the level of interest rates that is the problem. Instead, stress is because of the loans already on PSB balance sheets, and their unwillingness to lend more to those sectors to which they have high exposure. There are two sources of distressed loans – the fundamentals of the borrower not being good, and the ability of the lender to collect being weak. Both are at work in the current distress.

The Governor of the Reserve Bank is much more than just a regulator or a central banker. Since the RBI is both the lender of last resort, as well as the custodian of the country’s foreign exchange reserves, the Governor is the primary manager of macroeconomic risk in the country. If the Governor takes this role seriously, he (or she) has to warn when he fears the economy is in danger of going down the wrong path. As an apolitical technocrat, he can neither be a cheerleader for the government, nor can he be an unconstrained critic. This is a fine line to tread, and the Governor has to pick both the issues he speaks on, as well as the tone of his commentary, very carefully.

The mistake on all sides is to treat the RBI Governor as just another bureaucrat. If the Governor takes this mistaken view, he ends up being subservient to the central and state governments, and not offering an independent technocratic perspective that could keep the nation from straying into economic distress. The RBI Governor has to understand his role, and know it occasionally entails warning of macroeconomic risks from government actions or saying ‘No!’ firmly.

Because of the relentless press attention, I realized that many young people who were looking for a role model now saw the Governor of the Reserve Bank as one they wanted to learn from and imitate. I felt I had to display the highest professional integrity, over and above the obviously necessary personal integrity, if I were to discharge my responsibility to these youth.

Our provision of public goods is unfortunately biased against access by the poor. In a number of states, ration shops do not supply what is due, even if one has a ration card – and too many amongst the poor do not have a ration card or a Below Poverty Line card; teachers do not show up at schools to teach; the police do not register crimes, or encroachments, especially if committed by the rich and powerful; public hospitals are not adequately staffed and ostensibly free medicines are not available at the dispensary; … I can go on, but you know the all-too-familiar picture. This is where the crooked but savvy politician fits in. While the poor do not have the money to ‘purchase’ public services that are their right, they have a vote that the politician wants. The politician does a little bit to make life a little more tolerable for his poor constituents – a government job here, an FIR registered there, a land right honoured somewhere else. For this, he gets the gratitude of his voters, and more important, their vote.

So the circle is complete. The poor and the underprivileged need the politician to help them get jobs and public services. The crooked politician needs the businessman to provide the funds that allow him to supply patronage to the poor and fight elections. The corrupt businessman needs the crooked politician to get public resources and contracts cheaply. And the politician needs the votes of the poor and the underprivileged. Every constituency is tied to the other in a cycle of dependence, which ensures that the status quo prevails.

There is a danger when we discuss ‘Make in India’ of assuming it means a focus on manufacturing, an attempt to follow the export-led growth path that China followed. I don’t think such a specific focus is intended. First, as I have just argued, slow-growing industrial countries will be much less likely to be able to absorb a substantial additional amount of imports in the foreseeable future. Other emerging markets certainly could absorb more, and a regional focus for exports will pay off. But the world as a whole is unlikely to be able to accommodate another export-led China. Second, industrial countries themselves have been improving capital-intensive flexible manufacturing, so much so that some manufacturing activity is being ‘re-shored’. Any emerging market wanting to export manufacturing goods will have to contend with this new phenomenon. Third, when India pushes into manufacturing exports, it will have China, which still has some surplus agricultural labour to draw on, to contend with. Export-led growth will not be as easy as it was for the Asian economies who took that path before us. I am not advocating export pessimism here – India has been extremely successful at carving out its own areas of comparative advantage, and will continue to do so. Instead, I am counselling against an export-led strategy that involves subsidizing exporters with cheap inputs as well as an undervalued exchange rate, simply because it is unlikely to be as effective at this juncture. I am a...

For example, rebellious youth in the United States used to burn the American flag. It was calculated to upset the older generation that had fought in America’s wars, for the flag was a symbol of all they had fought for. And the police, many of whom were veterans, used to react with violence, which was precisely the reaction the rebels sought to further their cause. Over time, though, U.S. society has become more tolerant of flag-burning. Because it no longer triggers a reaction, it is no longer used as an instrument to shock. In sum, if group sentiment becomes more tolerant and less easily hurt, the actions that try to hurt it will diminish. As Mahatma Gandhi said, ‘The golden rule of conduct is mutual toleration, seeing that we will never all think alike and we shall always see Truth in fragments and from different points of vision.’

Growth, however, is just one measure of performance. The level of per capita GDP is also important. We are still one of the poorest large countries in the world on a per capita basis, and have a long way to go before we reasonably address the concerns of each one of our citizens. We are often compared with China. But the Chinese economy, which was smaller than ours in the 1960s, is now five times our size at market exchange rates. The average Chinese citizen is over four times richer than the average Indian. The sobering thought is we have a long way to go before we can claim we have arrived.

We must remember that our international reputation is of a country with great promise, which has under-delivered in the past. This is why we are still the poorest country on a per capita basis among the BRICS. We need to change perceptions by delivering steadily on our promise for a long time – by implementing, implementing, and implementing. We cannot get carried away by our current superiority in growth, for as soon as we believe in our own superiority and start distributing future wealth as if we already have it, we stop doing all that is required to continue growing. This movie has played too many times in India’s past for us to not know how it ends.

For the last few months India has experienced large inflows of capital, not outflows, and is seen by the markets as an emerging economy that has made some of the necessary policy adjustments. We are well buffered with substantial reserves, though no country can be de-coupled from the international system. My remarks are motivated by the desire for a more stable international system, a system that works equally for rich and poor, large and small, and not the specifics of our situation.

It has often been said that India is a weak state. Not only are we accused of not having the administrative capacity of ferreting out wrongdoing, we do not punish the wrongdoer – unless he is small and weak. This belief feeds on itself. No one wants to go after the rich and well-connected wrongdoer, which means they get away with even more. If we are to have strong sustainable growth, this culture of impunity should stop. Importantly, this does not mean being against riches or business, as some would like to portray, but being against wrongdoing.

We also need to communicate better with the outside. This means that we should get ahead of the press, rather than be reactive. If we want to highlight achievements or regulations, we should prepare a press release to focus the press on what is important – with the release getting to the point quickly rather than starting with pages of irrelevant history. Press releases are best done at or before 5.30 pm if you want it to show up in the papers. Beyond that, reporters do not have the time to write copy for the next day, and the news is too old for the day after. Some in the Bank disdain communication. ‘Why not let our achievements speak for themselves?’ they might say. Unfortunately, in this world where the press is more attentive and the public more hungry for news, we either should shape news or we will be shaped by it. The latter is infinitely more unpleasant – some may recall the way we were termed anti-technology for some actions we took against a taxi company.

It is dangerous to have a de facto powerful position with low de jure status. Today, the RBI Governor has the salary of the Cabinet Secretary. He or she is appointed by the Prime Minister in consultation with the Finance Minister. The Governor’s rank in the government hierarchy is not defined but it is generally agreed that decisions will be explained only to the Prime Minister and the Finance Minister. There is an informal understanding in India that the Governor has the room to make needed decisions. In the interests of macroeconomic stability, none of this should be changed, though if these issues are ever revisited, there may be some virtue in explicitly setting the Governor’s rank commensurate with her position as the most important technocrat in charge of economic policy in the country.

While these changes in the financial landscape have been termed ‘disintermediation’ because they involve moving away from traditional bank-centred ties, the term is a misnomer. Although in a number of industrialized countries, individuals don’t deposit a significant portion of their savings directly in banks any more, they invest indirectly in the market via mutual funds, insurance companies, and pension funds, and in firms via venture capital funds, hedge funds, and other forms of private equity. The managers of these financial institutions, whom I shall call ‘investment managers’, have displaced banks and ‘reintermediated’ themselves between individuals and markets.