Policy making is about deciding in the face of uncertainty

Over the last few weeks, I have outlined the Reserve Bank of India's (RBI's) approach to inflation, distressed debt, financial inclusion, banking sector reform, and market reform. Here, I'd like to first discuss why central banking is not as easy as it appears (just raise or cut interest rates!) and why it needs decisions, sometimes unpopular or hard-to-explain ones, to be made under conditions of extreme uncertainty. This will then lead in to my arguments about why we need an independent central bank.  
To set the stage, think back to the summer of 2013. After Chairman Bernanke hinted that the United States might end quantitative easing (QE), capital started flowing out of emerging markets, especially those deemed to have weak macroeconomic fundamentals. India, with high fiscal deficits, high current account deficits, and near double digit inflation, was deemed one of the "Fragile Five" countries. The rupee plunged as debt investors scurried to safe havens. The talk in international markets was that the rupee could reach a hundred to the dollar, and some international commentators, knowing little about India, talked about an Indian "crisis".
In early August 2013, I was appointed to succeed Dr. Subbarao as Governor of the Reserve Bank of India (RBI). From the Finance Ministry, I went to the RBI to prepare for the transition.  
We had to get back the confidence of international investors. And that meant convincing them that India was still an attractive place to invest in, despite the then paralysed economic reforms. Furthermore, they had to believe that the rupee would retain its value going forward.
So I went from room to room asking RBI staff what they were working on, and what ideas for financial sector reform they were prepared to contemplate. We packaged our ideas into a reform programme over the medium term that could change the narrative on India, especially given the fiscal reforms the government had initiated.  
To bolster the value of the rupee, we had to give investors more certainty that future inflation would be low. After all, it was primarily India's higher inflation with respect to the rest of the world that led to periodic abrupt falls in rupee value. Then Deputy Governor and now my successor, Dr. Urjit Patel, agreed to prepare a report on how we could move to a new inflation-focused monetary regime. That would help very much in the medium term, but in the short run we had to establish that we were not heading towards crisis. The easiest way to demonstrate that was to show we could raise plenty of foreign exchange.
My thought turned to an iffy scheme that had been presented to me in North Block. Essentially, bankers had told us they would bring plenty of dollars in as FCNR(B) three-year deposits, which they would convert to rupees and invest in India. In return, they wanted a cheap rate at which they could convert rupees back into dollars three years hence. So long as the Reserve Bank could be trusted to provide the forward dollars, this was a great deal for the banks - they got rupee interest income and a guaranteed cheap price at which they could swap maturing rupees back into dollars.  
I did not think much of this scheme when I first heard of it, dismissing it as a clever ploy by bankers to get a subsidy from a country in trouble. But it refused to go away, and my old colleagues at the finance ministry thought it worth a try as the crisis of confidence worsened.  
I too became more favourable after thinking carefully about it. First, I weighed the balance of risks. If we did not move the rupee back to fundamental value, every one rupee rise in the dollar-rupee rate  would costs us Rs 400 billion (40,000 crores) more in import costs. Assuming the rupee was undervalued by Rs 3.0 for a couple of years, this would mean a loss of lakhs of crores to national income. In contrast, even if the scheme was wildly successful in attracting inflows, the payout would only be in the tens of thousands of crores. Of course, there might be cheaper ways of restoring confidence but it was not clear what they were.
Discussions with my soon-to-be colleagues at the RBI threw up another rationale. The bankers who proposed the scheme were saying that if the money came in, the rupee would appreciate, and it would cost us less to offer the forward subsidy. This was self-serving and not quite right. What was right was that if we changed the narrative on India, and the rupee continued appreciating between the point when the money came in and the point we covered our liabilities to the bankers in forward markets, it would cost us significantly less. In fact, we might even make money on the deal. But what if the rupee plunged after the dollars flowed in? There were no certainties here.
The bottom line was that the scheme was a measured risk, with a probability that the RBI would lose money, a certainty that the bankers would make money, but also a reasonable chance that the country would be significantly better off. Having obtained the concurrence of the Finance Ministry, the RBI Governor had to decide.  
Policy making is about deciding in the face of uncertainty, after weighing the alternatives as best as one can. On the day I was to take over, with no good options on the table, I had to choose the least bad one. I decided to go ahead.
The afternoon of September 04, 2013, we announced the package of measures. The FCNR(B) scheme drew in $26 billion, more than any of us anticipated. But more important, confidence picked up, the rupee continued strengthening beyond when the money came in, partly because the global investor mood as well as Indian electoral projections also changed, and we covered our forward swaps cheaply. We are fully covered for outflows today and have made money on the deal. The rupee has been one of the most stable emerging market currencies since then.
Of course, in hindsight it seems like it was the obvious thing to do because it worked.  The reality is we will never know for certain! Perhaps it was the other elements of the package, perhaps it was everything together. Autobiographies are always written as if the author had it all mapped out with perfect foresight, ignoring the risks and uncertainties at that time. This misleads, as much as those beautiful photographs of a past holiday abstract from the heat, the mosquitoes, and the lack of connectivity. Policy making invariably involves taking measured risks in the face of uncertainty.  
Clearly, we do not want to be in the position we were in August 2013 ever again. Macroeconomic stability is of paramount importance for India. Equally clearly, drawing from this experience, the central bank must have the resources, the knowledge, and the professionalism to act when the situation warrants.
This is a slightly edited version of the last public speech Raghuram Rajan gave as RBI Governor on September 03, 2016 at
Stephen's College, New Delhi, link: https://rbi.org.in/Scripts/BS_Speeches
View.aspx?Id=1021. Rajan left RBI the next day, September 04.