Jalan, the big-picture man

C Rangarajan's tenure as Reserve Bank of India (RBI) governor was cut short by a month. From Mint Street, Rangarajan moved to Raj Bhavan in Andhra Pradesh.

His successor Bimal Jalan is also set to move out of the central bank before he completes his term (in November next year) but he is headed for the upper house of Parliament.

When that happens as is expected over the next few weeks, Jalan will leave Mint Street with the distinction of having the second longest tenure as governor in the bank's 68-year-old history (Sir Benegal Rama Rau was governor for over seven years between July 1949 and January 1957).

Only time and, of course, the Bharatiya Janata Party (BJP) can tell whether Jalan will, like Manmohan Singh, become finance minister (although there was a long interregnum between Singh's governorship and appointment as finance minister).

Jalan is being nominated in place of scientist Raja Ramanna. His presence in Parliament is no big gain for the Rajya Sabha. But for the Indian economy it is a big loss. Like politicians, central bankers are not handicapped by age.

At 62, Jalan could certainly have had a longer innings at the RBI. By packing him off over a year ahead of his extended term the government is also making it clear that it is not willing to create an Alan Greenspan in south Asia.

Jalan took over in November 1997 at the height of the south-east Asian crisis when the RBI was spending a billion dollars a week to stem the fall of the rupee.

On being asked whether he was comfortable with the level of the rupee at his first press conference as RBI governor, a visibly uncomfortable Jalan mumbled: "Yes, I am."

The next day, the foreign exchange market took advantage of Jalan's apparent naivete and tanked the Indian currency. From the next day, Jalan stopped talking about the level of the Indian rupee.

He also changed the style of intervention, deciding that it was not worth wasting billions of dollars to keep the rupee high. From being taken for a ride by the market in his initial days, Jalan had the market eating out of his hands.

Bankers, too, found the country's chief money man something of a rarity. When he took charge, Jalan invited senior bankers for a get-to-know lunch meeting.

The bank CEOs turned up in their regulation grey suits and ties; imagine their reaction when the new RBI governor walked in casually dressed in a white full-sleeved shirt (untucked) and chappals. As the meeting progressed, bankers understood that Jalan's casual sartorial sense did not extend to his official brief.

Jalan is not hugely interested in the nuts and bolts of the financial system; he likes to keep his eye on the big picture. The net result of this new approach?

There is plenty of liquidity in the financial system, the bank rate is at a three-decade low, gilt yields have never been lower, foreign exchange reserves are close to $82 billion (compared to roughly $27 million when he took over), inflation is at 5 per cent, the balance of payment situation is rosy and the country has had a current account surplus for two successive years. This is a dream balance sheet for a central banker to sign off on (and for a government to launch its election campaign).

If you exclude the balance of payments crisis and economic reforms of the early nineties, the Jalan era has coincided with possibly the most eventful time in the Indian economy.

Even as the southeast Asian crisis blew over, Jalan followed the Pokhran nuclear test and its fallout in the form of US sanctions; a stock market scam that involved some banks; several cooperative bank scandals; drought; and the worst kind of riots in decades.

Overseas, currency and banking crises engulfed Mexico, Argentina, Brazil, Japan and Russia. And, finally, there was the oil crisis and the US war against Iraq. All through, the RBI held the ground firm and the economy showed its resilience despite downgrades by rating agencies.

To Jalan's credit, he did not fight shy of following a closed currency policy when it was needed and opening up on the capital account with gradual but sure steps once the cloud was lifted. Even now, the RBI favours capital account convertibility for all investment and production demand but not for holding idle domestic assets because it does not want to risk the fate of Latin America.

Jalan has also been able to substantially change the approach to monetary policy. For example, the biennial event of the credit policy has become a mere ritual, shorn of surprises. There is also a perceptible shift in the philosophy of monetary management: Instead of surprising the market, RBI plays to its expectations.

The flip side of this, of course, is that it is killing the bond yield curve. In India, 364-day treasury yield is around 5 per cent and 10 year-paper is at 5.75 per cent. This makes the spread between one-year and 10-year paper 75 basis points . In the US, the spread between two-year and 10-year paper is about 2.35 per cent.

This is happening because the RBI is artificially keeping the short-term interest rates high. At the longer end. too, it ensures that there is little volatility in the movement of rates.

Theoretically, a flat yield curve projects a grim outlook for the economy. But this is not the case in India. So why does the RBI prefer to keep it flat? That's because as the government's merchant banker, it has to see through its massive borrowing programme and any jump or drop in rates will jeopardise the programme.

Jalan has, however, made the government see the structural infirmities in the overall interest rate architecture and forced it to cut the politically-sensitive administered rates. This, in turn, helped the RBI to push down the rates across all instruments in the financial sector.

But the benefit to the corporate sector is restricted to only the triple-A rated companies. When zero-risk government papers ensures a 5.75 to 6.5 per cent return, why should any bank chase corporate customers to lend money? Jalan brought down the interest rates but failed to ensure that the benefit would be passed on to all borrowers.

Can he be blamed for this? To be fair, this is a political issue and, after all, the RBI governor is a political animal. His passage to Rajya Sabha only highlights this truth.