Dr Raghuram Rajan, mind the sharks on Mint Street

No one doubts the top-of-the-class credentials Raghuram Rajan brings to the top job at the RBI. He is intellectually brilliant, absolutely honest and a thoroughly decent man. Unfortunately, in India’s rotting system of Government, these qualities are not enough, by themselves, to ensure success.

Just ask Dr Manmohan Singh. There will be any number of crabs waiting to pull the new Governor down, and an equal number of sharks waiting to gobble up the ‘outsider’. In the end, Rajan’s success or failure may be determined not so much by how he handles the “Impossible Trinity” of managing growth, inflation and exchange rates simultaneously but by how he copes with the “Impossible Trinity” of the RBI bureaucracy, North Block and vested interests in the financial sector.

The RBI is still unusual among Indian Government institutions because it retains a strong sense of independence (from the Finance Ministry) and has a reputation for integrity (no major scam has been reported from there). Of course, successive governors, whether they were from the IAS or economists, will claim credit for this. The head of an institution definitely sets it moral compass. But RBI’s ability to maintain its individuality, without getting sucked into the black hole of government in general, is because it has its own dedicated cadre of officials. Unlike other government bodies, it is not staffed by IAS, IRS, and Audits and Accounts Officers who move within Government frequently, carrying the decay from one ministry/department to another contagiously. RBI’s massive bureaucracy is staffed by those who spend their entire careers in Mumbai’s Mint Street after getting in through a competitive RBI exam. They guard their institutional pride fiercely.

There is a corollary to this. RBI’s bureaucracy is totally insular, prone to group-think and resistant of change. Raghuram Rajan has several radical ideas to reform the RBI. For one, he would not like the RBI to manage the impossible trinity and instead focus on battling inflation alone. For another, he would prefer that the RBI did not conduct monetary policy, regulate banks and manage the Government’s debt simultaneously. Of the three, he would be minded to hive off the Government’s debt management to an independent body. These are ideas that the RBI’s gigantic bureaucracy - mostly in Mumbai but also in eight other cities - will resist. They derive their power and privilege from performing all these tasks. Rajan will be Governor for 5 years at most after which he will return to the University of Chicago. The RBI bureaucrats have a lifetime to spend in the institution. Their interests are different, Rajan will, therefore, have to be deft in man management if he is to be an effective reformer.

The political class will be the second leg of the impossible trinity that Rajan will have to contend with. The new Governor may run into rough weather with even the instinctively reformist P Chidambaram who has made it clear in recent weeks that he fully expects the RBI to manage the multiple objectives of growth, inflation and exchange rate, even though the previous two RBI governors, YV Reddy and D Subbarao failed miserably at the task. It is theoretically and practically impossible for any central bank, in an open economy with free capital flows, to manage the exchange rate. A futile battle, using interest rates, the only powerful instrument in the hands of the RBI, only makes the task of boosting growth and controlling inflation that much harder. Rajan knows this well but can he stand up to Chidambaram or any future finance minister? Sounds impossible? If, however, he succumbs to the political sharks on exchange rate management, he is bound to fail.

The third and last thing Rajan needs to watch out for is vested interest in the financial sector. He will need to perform a tightrope act as he sets out to liberalise India’s still over conservative financial system. As he pushes along, he must take care not to become victim of a scandal. The pending banking licences - to be handed out over the next 6 months – are a good case-in-point. The UPA’s track record in transparency while doling out licences of any form is pathetic to say the least. Crony capitalists are always ready to play the system. As head of RBI, Rajan must ensure, by stepping over the toes of politicians if necessary, that the banking licences are given out totally transparently. He cannot afford a whiff of scandal so early in his tenure. To many, doing so may seem “impossible”.

Fortunately for Rajan, it is perfectly possible to manage the impossible trinity of RBI bureaucracy, North Block and vested interests in the financial sector. But it would require guts, superb man management and absolutely no desire to win kudos from anyone within the system. For India’s sake, Rajan needs to perform some magic.