Doctor C Rangarajan stepping down from chairmanship of the PM’s official economic advisers is, fortunately, not a sign that his role as a policy-maker is coming to end; he has become a Rajya Sabha MP and it has even been speculated he may be invited into the Cabinet.
India has been experiencing high recorded inflation in recent months. The most disconcerting aspect of this may be that it seems to be accelerating — from 5 per cent to 7 per cent to 9 per cent and now to over 12 per cent going by the WPI index, and climbing. Predictions that inflation will somehow moderate by winter do not seem to have a sound basis. The fact of the matter is no government agency, international organisation or private body has any robust comprehensive macroeconomic models of India’s economy to back up such politically-wishful optimism. It may be as likely as not India is headed towards a mild hyperinflation by 2009. And inflation’s main causes in an economy as large and as relatively unexposed to world trade as India’s will be our own macroeconomic mistakes, not exogenous factors from outside.
What the national interest requires in the event of a hyperinflation is a prudent, non-partisan, technical response in economic governance. Rangarajan is of the same generation of Indian economic officials as the prime minister himself and it is a matter of good fortune that though they are very different by economic training, experience and outlook, they have been mutually respectful professional friends. Manmohan Singh, as the RBI Governor in December 1982, appointed the Sukhamoy Chakravarty Committee “to review the working of the monetary system”. Rangarajan, then an economics professor, was an influential member of that Committee — indeed, the late Professor Chakravarty told me personally in July 1987 that Rangarajan had been the driving force and main author of the influential report the Committee came to submit in April 1985. Rangarajan was a monetary economist among Indian policy makers. In a nutshell, what the Chakravarty Committee succeeded in doing was to start a process of restoring some kind of mo netary policy in the country for the first time since the 1930s.
In his Kutty Memorial Lecture in 1993 “Autonomy of Central Banks” (whose title speaks for itself), Rangarajan quoted with much approval Sir George Schuster, the dedicated civil servant who had been de facto finance minister of India 60 years earlier.
Schuster had introduced the Reserve Bank of India Bill with these words: “In modern life and in modern economic organisations, there are two important functions: There are the functions of those who have to raise and use money and there are the functions of those who are responsible for producing the actual tokens of money, the money in circulation. The basis of the whole proposal for setting up an independent central bank is to keep those two functions separate. The largest user of money in a country is the government, and the whole principle of the proposal is that the government, when it wants money to spend, should have to raise that money by fair and honest means in just the same way as every private individual has to raise money which he requires to spend for his own maintenance. If the government is in control of the authority responsible for exercising the other function, then all sorts of abuses can intervene.”
In the same spirit, Rangarajan said the Chakravarty Committee had “recognised the dangerous trajectory that the monetary-fiscal policy was on and strongly recommended a fundamental restructuring of the monetary system. The Committee argued that price stability should be the dominant objective of monetary policy and inflation control was perceived as the joint responsibility of the Government and the Reserve Bank”.
In practice, as deputy governor and then governor of the RBI, Rangarajan succeeded in launching a coherent campaign to reduce and then eliminate the arbitrary financing of government debt by rampant whimsical use of what used to be called “ad hoc Treasury bills”. The RBI’s balance-sheets appear much cleaner today as a result; the graph shows what may be called a “Rangarajan Effect” on the distribution of sources holding India’s public debt. Rangarajan, along with another pioneer of Indian macroeconomics in recent decades, Raja Chelliah, may be credited with having tried to bring to bear some sobriety and rational principles upon the otherwise drunken processes of our public finance whereby large deficits are being continually paid for by paper money creation. Manmohan Singh, though not a monetary economist, may be credited too with this institutional progress as he, as the RBI Governor, appointed the Chakravarty Committee and a decade later was finance minister when Rangarajan became RBI governor.
Yet this progress may not be enough to control or prevent a possible hyperinflation in coming times. The RBI holding less government debt may have meant our (mostly nationalised) commercial banks having to hold more, which causes the following dilemma. If the rupee becomes convertible (so ordinary Indians can all have the same privileges as those glamorous jet-setting NRIs to hold and trade gold and foreign currency assets), the artificially-protected balance-sheets of India’s banking sector will be inevitably re-evaluated at world prices. That may see the vast amounts of union and state government debt being held as bank-assets becoming priced at a discount, with inevitable consequences for financial stability. On the other hand, leaving the rupee without convertibility leaves vast scope for continuing abuse while also distorting domestic monetary prices (including interest-rates and wages) away from internationally-competitive values. We may still be on the “dangerous trajectory” that Rangarajan and the Chakravarty Committee began to identify a quarter century ago.