9/5/2014

The man who turned the economic tide - The Hindu

Opinion Comment
The man who turned the economic tide
Raghuvir Srinivasan

THE RAJAN EFFECT: It would not be an overstatement to say that the background of Raghuram Rajan with his formidable academic
credentials, his sure-footed moves and his confident statements went a long way in calming the nervous markets. Picture shows the RBI
Governor in Mumbai. Photo: Paul Noronha

The Hindu

As he completes his first year as Governor of Reserve Bank of India, Raghuram Rajan can afford to look back with a sense of
satisfaction at a job well done

Raghuram Rajan assumed office a year ago at a time of soaring inflation, receding growth prospects, widening
deficit on the current account and a veritable run on the rupee which was in free fall. A year since, inflation is under
control, the economy is bouncing back, current account deficit has been whittled down to an insignificant statistic
and the rupee has reversed trend to such an extent that it is the best performing emerging markets currency in the
last one year.
Admittedly, not all of it is the Rajan effect. The heavy lifting in terms of shoring up the rupee and reining in the
current account deficit was done by his predecessor D. Subbarao but Dr. Rajan managed the fallout well and rolled
out further nuanced policy measures such as the special foreign currency swap arrangement with banks for attracting
deposits from NRIs. It would not be an overstatement to say that the background of Dr. Rajan his formidable
academic credentials, his initial sure-footed moves that were closely watched and his confident statements went a
long way in calming the nervous markets. So much so that when the markets began to reverse direction soon after,
pundits were quick to term it the Rajan rally.
Battle against inflation
But combating currency speculators and steadying the rupee was just the immediate priority; there remained the
larger problem of quelling inflation and helping the Centre pursue its growth agenda. This is where Dr. Rajan
surprised long-term Reserve Bank of India (RBI) watchers who, given his Chicago school moorings, did not expect
him to adopt a conservative approach. Yet, that is exactly what he did raising benchmark interest rates twice
within the first two months and raising them yet again in January 2014. It must not have been easy for the RBI
Governor, given that the government was in election mode, growth was slipping and the corporate sector was
screaming from the rooftops for a reduction in rates.
Whats more, he took the battle against inflation to the next level by targeting consumer price inflation rather than
wholesale price inflation, which has traditionally been the benchmark for the RBI. This was one of the important
recommendations of the Urjit Patel Committee that he constituted on his first day in office and a key reform
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9/5/2014

The man who turned the economic tide - The Hindu

measure that he accomplished within a few months of assuming office. The RBI may have tasted greater success in
quelling inflation if only it had got adequate support from the Centre, as much of the price rise, especially in food
commodities, was due to supply-side factors.
Dr. Rajan also managed to make the process of handing out new bank licences transparent and controversy-free,
though he is still far from redeeming his initial promise of licences on tap. The RBI Governor has also not been able to
persuade foreign banks to open wholly owned subsidiaries in India, which is important from the regulatory point of
view given the experience with the 2008 crisis. Despite the freedom to open more branches that comes with
subsidiarisation, foreign banks have refused to take the RBI bait and this will be a work in progress for Dr. Rajan for
the remainder of his term.
Some limited successes
The RBI Governor has also tasted only limited success in prodding banks to move away from their lazy banking
habits. The two cuts in statutory liquidity ratio aggregating to 1 percentage point have to be seen in this context. Dr.
Rajan was clear in his view that banks should be more active in lending rather than simply parking their funds in
government securities. That bank lending has not picked up in the last one year is something that the Governor must
surely be conscious of.
Dr. Rajan may also derive only limited satisfaction from his moves on reining in bad loans. He had signalled an
aggressive intent in that speech on his first day when he said promoters do not have a divine right to stay in charge
even when they mismanage. It has taken more than a year to see the first impact of that aggression just this week
United Bank of India (UBI) declared Vijay Mallya and Kingfisher as wilful defaulters. The RBIs resolve in
pushing banks to clean up their balance sheets and haul up recalcitrant borrowers will be fully tested in the months
ahead. As banks begin to crack the whip, there is bound to be political pressure from influential borrowers, some of
whom also occupy public offices. Handling the fallout will be one of the most important tasks for Dr. Rajan in his
second year in office.
The RBI Governor also faced his first setback on reforming the central bank when his proposal to appoint a chief
operating officer elicited opposition from within, including the unions. Though he moved quickly to control the
situation, his moves on this front will be closely watched.
The tricky path ahead
As the growth impulse returns in the economy, the RBI will be faced with the renewed threat of a bounce back in
inflation. The RBI Governor has set a target of 8 per cent for consumer price inflation by January 2015 and 6 per cent
by January 2016 and he will be tested to the full in meeting those targets. With retail inflation close to the targeted
level now and wholesale inflation also soft, pressure is already mounting on the RBI to take a re-look at interest rates.
This is where the tricky part begins for Dr. Rajan while he has to be conscious of his responsibility to keep prices in
check, he also needs to ensure that his moves do not end up discouraging investment.
The good news though is that he seems to have struck a good rapport with the powers in New Delhi. This is
important, not just in the conduct of monetary policy, but also in the context of the recommendations of the Financial
Sector Legislative Reforms Commission which, if implemented, will curb the role of the central bank. If Dr. Rajans
good understanding with the Centre is sustained, we could well see more reforms from the RBI in the months ahead.
raghuvir.s@thehindu.co.in
Keywords: Raghuram Rajan, RBI Governor, Indian economy, inflation, GDP, CAD, consumer price
inflation, economy, India,
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