Just 48 hours into Duvvuri Subbarao’s new job as governor of the Reserve Bank of India (RBI), the US set off a global panic as it temporarily nationalized mortgage lenders Fannie Mae and Freddie Mac.
It was the biggest government intervention in private financial markets in history. A week later, the collapse of Lehman Brothers plunged the world into the biggest financial crisis since the 1930s depression.
Despite the health of Indian banks at the time, the seizing up of global credit markets and subsequent collapse of market confidence, triggered a temporary freezing of domestic credit.
The Reserve Bank of India’s response was immediate – it injected vast amounts of liquidity into the country’s financial system. “We decided that the impact of the evolving crisis could potentially be big enough for us to reverse the tightening mode and that we must signal that the RBI was at the forefront of combatting the crisis,” Subbarao tells Emerging Markets in an interview at RBI’s headquarters in Mumbai.
Until September last year most economists had argued that India’s relatively closed financial system, low level of private debt and low dependence on external trade would barricade the country from the financial hurricane. “However, between October and December, we realized that the crisis was spreading through the financial and confidence channels as well as the real economy channel, and that the impact on India was more than that anticipated earlier,” says Subbarao.
As a result, the governor slashed the policy rate from 9% to 3.25%, cut the cash reserve ratio, the proportion of deposits commercial banks must park in the RBI, from 9% to 5%, and made it easier for banks to buy government paper.
These moves generated some Rs5.6 trillion – about $120 billion – of liquidity to combat the crunch and boost the economy.
The governor’s monetary stimulus was one of the most aggressive in Asia. Subbarao deployed almost every conventional policy weapon in the RBI’s arsenal.
Subbarao’s reaction was all the more impressive given his lack of experience at the central bank. “I had no reference frame and was coming in with a fairly clean slate, and relatively untutored in central banking,” he says.
That said, he was well aware of the big picture, having been deputed by India as lead economist in the World Bank from 1994 to 2004. From 2005 to 2007 he was appointed to the prime ministers’ Economic Advisory Council from 2005 to 2007 after which he became India’s finance secretary.
His is still a complicated job. The RBI has been tasked with a torturous juggling act due to its full-service mandate: inflation warrior, economic growth driver, financial watchdog, and also, government debt manager.
As a result, Subbarao has been battling with the finance ministry over its Rs4.5 trillion borrowing programme this fiscal year. This spending has undermined the RBI’s mission to lower market interest rates. Nevertheless, with inflation rising, the RBI may raise rates earlier than the government expects – or wants.
Subbarao has been an effective crisis manager, but his mission to combat the fiscal deficit while ensuring price stability may have only just begun. —Sid Verma