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Bimal Jalan: The knight of January 14

Haseeb A Drabu | August 21, 2003

A record level of foreign exchange reserves, a low rate of inflation, lowest ever interest rates, a stable exchange rate and a money supply well within target.

What more can the chief of any central bank want to leave as a legacy? In one word, nothing. No wonder then, Bimal Jalan says that he is leaving at the right time! The monetary scenario couldn't have been better.

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So, is this what Jalan should be remembered for? Perhaps not. Even though from an economic historian's point of view, such an enviable monetary legacy will be a mile-post.

Without trying to belittle these achievements, the fact is that the domestic trends in the variables like inflation and interest rates are by and large mirroring the global trend.

Nor for that matter has there been any great deal of proactive policy initiative that has led to these reserve buildups.

Jalan should be remembered for what he did when he came in rather than what he leaves behind. He fought and decisively won a battle barely a couple of months after he took over.

And like all great generals, he will be remembered for his battle on the exchange rate front. Indeed, the seeds of his success in overall monetary management were sown in January, 1998. To be precise, on 14th January 1998.

On November 21, 1997, when Bimal Jalan took over as the Governor, the rupee had dropped to Rs 37.42 to a dollar. And before he could settle in his new office, the rupee had touched a low of Rs 38.52.

A week later the rupee reached Rs 39.30 to a dollar. Even though he did not try to defend a particular level of the exchange rate, Jalan spent around $3 billion to stem the fall. But it was becoming a mugs game.

With foreign portfolio investors selling their holdings and the East Asian crisis continuing, the prospects of inflows for the next three months didn't look favourable.

Foreign institutional investor inflows were ruled out till after the elections and so were fresh GDR collections. External commercial borrowings were not possible because the East Asian crisis had made emerging market debt expensive.

Jalan reckoned that the forex reserves were too precious to be squandered away, especially when there is no lender of last resort. When the rupee crossed 39, he hiked the CRR to 10 per cent. There was some respite. But two days later, the Lok Sabha was dissolved and elections announced. The rupee came under renewed attack and dipped to Rs 39.90.

Sensing an oncoming free fall of the rupee, fed by the self-fulfiling prophesies of the market, Jalan put together a strategy to checkmate any potential crisis.

He started shoring up the defences by hiking the interest on overdue bills and increasing the import surcharge. When the markets drove down the rupee to 40, on January 14, 1998, Jalan went for the liquidity jugular with the mother of all measures; increasing the bank rate and the Cash Reserve Ratio.

The 2 per cent CRR hike sucked out Rs 2,400 crore (Rs 24 billion) from the banking system. The overnight interest rates zoomed, making holding dollars very expensive and hurting the banks that had borrowed rupees to buy dollars.

The bank rate was also hiked by 2 per cent making refinance from the central bank expensive. The rupee inflows into the inter-bank market were stopped by increasing repo rates to primary dealers and export refinance was reduced and made more expensive to induce dollar repatriations.

All these measures -- tightening the money supply, forcing up the rupee interest rates and making dollar holdings expensive -- were textbook monetary techniques that had long become unfashionable. But Jalan revived them.

It may look like an easy decision now, but it was fraught with micro and macro risks. To save 50 paise on the rupee, the Governor had cost the banking system Rs 500 crore (Rs 5 billion).

The RBI had been encouraging banks to support the government borrowing programme and use gilts to reduce the level of non-performing assets and then turned around and hiked rates, which could have had a crippling impact on their balance sheets.

But then, had the rupee gone to say 45, FII confidence would have fallen and Indian companies with dollar loans could have gone bankrupt.

All in all, a very difficult choice especially when there was domestic political uncertainty and global financial uncertainty as the overall environment. The key was that Jalan had a perfect estimate of the panic that he created.

These measures came at a time, when the economists and policymakers all around the world were struggling to find answers to two crucial issues: how to detect the East Asian type of crises before it happened and how to insulate other economies from it.

The emphasis of policy debate is what countries should do at an individual level in order to build up their defences. When World Bank Chief Economist, Joseph Stiglitz observed that there was sufficient economic justification for doing something, the pendulum of policy action swung in favour of interventionist measures.

Stiglitz said, "If you believe that there ought to be someone involved in the bailout business, then you have to believe that there ought to be interventions to stop the events that lead to it."

He argued that financial crises are systematically related to financial market liberalisation, and that having better regulations can reduce the likelihood of such episodes.

Preventive measures should go beyond strengthening capital adequacy standards for financial institutions to setting restrictions on risky investments, he said.

Jalan had practiced a few months earlier, what the global gurus were preaching now. This was his crowning glory. The policy framework, till January 14, 1998, was not structured to prevent houses from burning down but rather to send some blankets after the fire is put out.

Jalan worked out and successfully implemented precautionary measures that stopped the house from catching fire. That is his contribution to monetary management.

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