Raghuram Rajan must first stabilise the economy. Then, he needs to help remake the institution he heads.
A host of short-run and long-term tasks demand the urgent attention of the new RBI governor as he takes charge. In the short run, Raghuram Rajan has to find ways to stabilise the economy. Amid falling GDP growth, and with inflation expected to decline, he should be cutting interest rates. Since that will put pressure on the currency, he must work on removing all kinds of irritants that the RBI has put in the way of capital inflows. Rajan has announced a series of steps to liberalise the financial sector, especially the banking sector. He has indicated that the direction of reforms would be towards greater openness and rupee internationalisation. He should follow this up by reversing all the retrograde controls placed by the RBI on capital flows, currency markets, gold and currency derivatives in the last two months. This should be done immediately. With these out of the way, Rajan can focus on the more difficult challenge at hand — steering the course of monetary and exchange rate policy.
In the longer run, as governor for the next three years, Rajan's job is to fundamentally reform the RBI into a modern central bank. This will involve redefining the mandate of the central bank and its functions, clearly defining the objectives of monetary policy and institutions related to the conduct of monetary policy, and redesigning the role of the RBI as a banking regulator. The Financial Sector Legislative Reforms Commission (FSLRC) has suggested that the RBI Act of 1934 be repealed and a new law be passed, making the objectives of monetary policy measurable, for which the RBI will be held accountable. Rajan's role is to help the finance ministry to choose the best nominal anchor and build an RBI that will be able to implement the new law.
Further, he must constitute a monetary policy committee (MPC) whose members would vote on the stance of monetary policy. The MPC's decisions should not be advisory but binding on the RBI. This structure is intended to change the current nature of the relationship between the RBI and the MoF, where, as the outgoing governor, D. Subbarao, pointed out in his parting speech, the RBI has limited independence. Rajan also has to work hard on getting rid of the conflicting objectives the RBI holds today (such as the government's debt management office) and address the reforms not implemented since the RBI has been fighting for turf. Converting the RBI into an independent and accountable central bank may not have been possible for any other governor till now. But with the FSLRC report and the draft law on the table, this is a task that is not only possible, but also urgently required.