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D.Subbarao And His Legacy

Posted in Finance Articles, Total Reads: 2801 , Published on January 10, 2014

“Getting into an expansionary monetary policy is much more difficult than getting out of it. It is like a ‘Padmavyuha’ in Mahabarata, you know how to get into it but not many people know how to get out.”

- D. Subbarao (January, 2010)

Three and a half years later the country is still pondering over the same dilemma, when the prophecy of D. Subbarao has almost come true. He handed over the baton to Raghuram Rajan in September 2013. D. Subbarao’s legacy is much wider than the recent implications of the monetary policy. His thoughts and staunch support to control inflation even at the cost of his personal conflicts is what will be missed the most.

Dr. D. Subbarao entered the Mint Street on 5th September 2008 as the new governor of RBI when the economy was into ruins due to the US sub-prime crisis. He is credited for steering the Indian economy safely from the global financial crisis. But in spite of his much applauded efforts rupee hit a record low of approximately 64 recently. Apart from controlling the fall of rupee, D. Subbarao’s successor Raghuram Rajan would need to tackle the growing inflation, calming the Forex markets, granting the new banking licenses and recovering the decade low growth.

History repeating itself

During September 2008, the CRR was hovering at 9% and repo rate was also at 9%. The inflation rate based on Wholesale Price Index was 11.06% during the same time. D. Subbarao tackled the global financial crisis by reducing the repo rate and CRR. The current scenario (2013) is also quite similar, inflation rate well above the RBI target rate of 5%, which is forcing it to tighten the monetary policy. But this is taking a toll on IIP rate which has gone negative recently. The automobile sector which was considered one of the fastest growing sectors since 2000 is also in trouble. Most of the major automobile companies are reporting lower volumes when compared to previous years. In addition, the manufacturing and mining sector has also reported negative growth rates. In spite of these concerns, to contain the inflation (especially food inflation), D. Subbarao tried to abandon the other objectives of RBI. One of the measures taken for containing inflation is the tightening of liquidity by checking the undue volatility in the foreign exchange market. This in turn preserves the depreciating rupee value, leading to reduced oil import bill and hence controlled inflation.

In July 2013, RBI lowered the GDP projection for the current fiscal to 5.5% from the earlier estimate of 5.7%. The conflict in this situation arose when the government wanted an easy monetary policy to support its policies and to bring the growth rate to 6.5%. According to the research report of a foreign brokerage firm Bank of America Merrill Lynch (BofA-ML) and Morgan Stanley, GDP growth rate would slip to 4.8% and 3.5-4% respectively due to the prolonging of liquidity tightening moves by the RBI. But according to D. Subbarao, “Without policy efforts to address the deterioration, productivity and competitiveness, the pressure from wage increases and upward revision of administrated prices could weaken growth even further and exacerbate the inflation pressures”.


Restrictions on Current account and Capital account

In August 2013, the RBI took several measures in a bid to protect the depreciating rupee against the dollar. These measures include imposing restrictions on Indian citizens and Indian companies which are planning to set-up companies outside India. As per RBI’s modified Liberalized Remittance Scheme, Indian residents are not permitted to remit more than $75,000 per financial year. This is a steep decrease compared to the previous limit of $200,000. In addition, RBI further said that this money cannot be invested in buying immovable property outside India directly or indirectly.

And for the Indian companies RBI had imposed restriction that they cannot invest more than 100% of their net worth in foreign countries without taking approval from RBI. In contrary there were no restrictions up to 400% of the net worth of the company. These changes are not applicable to the government owned Navaratna companies.

The above measures taken by the RBI would hinder the globalization drive and detract the overall reform process. It has been observed that outward investment by India has drastically come down $16 billion during 2011-2012 to $7.1 billion during 2012-2013. These measures would further dent the India’s strategic footprint in the global market place. The industry experts have shown their concern in this regard.

Mr S. Gopalakrishnan, the president of CII said, “With such a minimal amount of outflows impacted, the gains to the rupee may in fact not be as much as expected. We are deeply concerned, as it would disrupt ongoing investment plans.”

"Ironic that we have controls on capital on Independence Day. Feels like the 1980s. Well the silver lining is that I feel young again," said Anand Mahindra, Chairman, Mahindra & Mahindra.

In yet another step, the RBI had imposed restrictions on gold imports made by banks and other authorised agencies. As per the new norms, all banks and authorised agencies will have to ensure that at least 20 per cent of imported gold is made available for exports and a similar amount is retained with the customs.

Emerging banks

The RBI has issued only 12 banking licenses in the last two decades and it is high time to issue more banking licences to increase the competition, financial inclusion etc. In this regard, the union finance minister announced during the budget speech (2010-2011) that RBI was considering the grant of licenses to new private players.

Twenty-six applications were received by RBI which include Birla group, Tata group, L&T Finance, India Post etc. But RBI has not yet fixed any target over the minimum number of banking licenses to be issued. The restrictions have led to the lesser number of applicants than the RBI’s estimation. Few of the restrictions include: shareholding pattern of FDI, FII and NRIs; the lock-in period for the capital to be contributed by the promoters; the shareholding of Non-Operative Financial Holding Company (NOFHC) should be brought down below 40 per cent from the date of commencement of business of the bank; Capital Adequacy Ratio (CAR) has to be maintained at 13% for a minimum period of three years etc.

Financial inclusion has been in the limelight for a long time. This is one of the major challenges for the new banks because this would demand a heavy capital and may reduce the profitability. It would take new banks a long time to establish and to get a strong hold. Given the current market scenario, where the existing banks are facing challenges due to higher NPAs, risk due to the global downturn, implementation of Basel III norms and liquidity crunch, the new banks have to struggle a lot for their survival. But RBI is contemplating for long term gains from the new banks.

In India, knowledge on financial system is very low, especially in the rural areas where financial inclusion is poor. It is reported that, in high income economies 89 per cent of adults have their accounts in formal financial institutions compare to 41 per cent in developing economies. So, there is a large scope for financial inclusion in India.

Basel III norms

Basel-III norms, a set of international accounting standards for banking were scheduled to come into effect on 1st April 2013. This was scheduled on 1st January 2013 but delayed by three months to improve the CAR and other ratios. In the current market scenario with a liquidity crunch, the banks would face difficulty to follow the Basel III norms at least in the short-run. But the long-run challenges for the banks to be in accordance with the Basel 3 norms, is still a question.

D. Subbarao’s views and thoughts were oriented against Mundell’s well-known Impossible Trinity. In fact, after he formulated the Holy Trinity, he strongly believed in the possibility of co-existence of price stability, financial stability and sovereign debt sustainability. But he could not tackle the ‘trilemma’ of checking the inflation, managing the rupee and spurring the growth together. Inflation in India is primarily due to the food prices, which cannot be checked by the monetary policy alone and going for fast growth or exchange rate control would have worsened the inflation. D. Subbarao deserves hardly any discredit for today’s problems. He was not a magic wielder, but given the fact of RBI’s limited arsenal of resources, he gave his best to the country.

Raghuram Rajan has a herculean task of bringing the economy back into track. He has to decide whether to follow the approach of his predecessor D. Subbarao to concentrate on long term growth or to formulate a new strategy to tackle the ‘trilemma’. It is expected that he will be able bring better reforms and balance the three arms of the Impossible Trinity efficiently, where D. Subbarao was much criticized.

This article has been authored by Venkata Achyuth Kumar & Satya Harish from IIM RAIPUR


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