Raghuram Rajan's imminent departure from the RBI has been regretted by many who value competence in the making and implementation of economic policy.  Now that his departure is a done deal and the search for a worthy successor is underway, one must focus on the specific elements of his legacy that his successor must conserve and advance.

Rajan himself has listed some achievements and challenges in his farewell message to his RBI colleagues.   One major achievement is the Monetary Policy Agreement (MPA) between the Finance Ministry and the RBI, signed in February 2015 for which the credit should go equally to both. This agreement specifies clear goals for inflation, recognises that "the monetary policy framework shall be operated by RBI" and establishes an accountability procedure.

RBI and the Finance Ministry have differed on the orientation of monetary policy very frequently. Recall for instance the annoyance in Delhi when Governor Subbarao raised the repo rate from a low of 4.75% in April 2009 to 8.5% in October 2011. His very able predecessor Governor Reddy was also a source of irritation to North Block. Let us also note that in hindsight both these Governors did the right thing and kept our financial system away from irrational exuberance in the boom years and panicky retrenchment in the post 2008 global financial crisis. Hopefully the MPA will reduce the friction between North Block and Mint Road

Rajan's caution in reducing interest rates was criticised by many politicians, businessmen and commentators.  What if Rajan had given in to the clamour to reduce interest rates much earlier than January 2015 when RBI cut the repo rate by 25 basis points? Would inflation have been much worse? I doubt it, since the primary factors behind the ups and downs in the price indices have been food prices and the prices of imported commodities, particularly oil. Neither of this is very sensitive to the interest rate. Would investment have picked up if interest rates had been lowered sooner? Perhaps in the real estate sector but one doubts whether lower interest rates could have made much difference when projects were stalled because of over leveraging in the corporate sector and slow demand growth. The continued decline in investment despite the 150 basis point reduction over the past 18 months reinforces this scepticism.

Rajan deserves credit for some other achievements like the building up of foreign exchange reserves and containing exchange rate volatility, the game changing institutional innovations in payment systems and the  transparent manner in which new bank licences were given. But perhaps his most important  contribution will be the as yet incomplete Asset Quality Review (AQR)  that has forced banks to deal more frankly with stressed assets and put defaulters on notice. 

The problem is particularly acute in public sector banks (PSBs). As of end March 2016 their non-performing assets (NPAs) stood at Rs. 5.7 lakh crores, much of it reflecting large loans for infrastructure made without much thought and, perhaps, under political instruction during the boom years.  Add stressed assets and the volume of doubtful assets goes up to Rs. 8 lakh crores. The AQR launched by Rajan has forced banks to stop hiding these and make full provision in their books as required, which led to their showing a net loss of Rs. 18 thousand crores in 2015-16  The Government, as the owner of these banks has also stepped up to the plate and launched a series of reforms under the Indradhanush programme, the most critical one being the establishment of bureau headed by a man of unimpeachable integrity for board level appointments. The new Insolvency and Bankruptcy Code is another major development.

Restoring PSBs to health is vital, particularly for employment creating small and medium enterprises who, unlike the big corporates, cannot borrow abroad.  It can also mean a huge return to the Government. At present the marketcap  of all public sector banks is around Rs 3.4 lakh crores, which is only slightly more than the roughly Rs.3 lakh crore marketcap of HDFC.  If the

PSBs, which account for around 70% of banking assets attain the profitability of private sector banks, their marketcap could go up three-to-four fold.

The principal challenge for Rajan's successor is to work with the Bank Board Bureau and the Finance Ministry to complete these process of banking reform.  There are other  challenges - steering  our credit and foreign exchange markets through a crisis-prone global environment,  stabilising the working of the Monetary Policy Agreement and the new Monetary Policy Committee, and, in the medium term, consolidating the many valuable developments in the payments systems that are in the works.  The Government must choose a governor who has the domain knowledge and the drive to get this done and has a professional standing that can command the respect of finance market professionals.

The jockeying for the position has begun. In the past there was always a tug of war between the IAS economic administrators and the professional economic advisers in the Government.  I sense that the IAS chaps are now keener on heading the many regulatory authorities that have been established as the pay  there is more than twice as large as the Rs 2 lakhs a month that  the RBI Governor gets and the political oversight is far less vigorous than in the RBI. That is why the air waves are filled with names of many economists, and only a few bureaucrats and bankers are under consideration. Most of the press candidates, if I can call them that, are competent and have the requisite domain knowledge. Since they also happen to be good friends I for one will not choose but simply say that I would be happy if any one of them emerges as the final choice. The fear is pressures from the Sangh Parivar to pick some loyalist or sycophant. Hopefully the Prime Minister and the Finance Minister will resist this and choose a professional who will command respect in financial markets at home and abroad.