governance, political economy, institutional development and economic regulation

rajan thinker

Rajan the thinking central banker: photo credit: bloomberg.com

Raghuram Rajan, India’s central banking czar, will be history by September 2016. He enjoys unprecedented popularity and near cult status as Governor of the Reserve Bank of India. Some of this has to do with his youthful looks and fresh demeanor — unusual in a profession peopled by dour old men. But much of his appeal is related to the confidence and skill he brings to the job, which he plunged into in weeks, rather than the months, which are the usual learning curve.

Even business — usually taciturn about rooting for bureaucrats, has also publicly supported his conservative strategy to keep the rupee stable; build foreign reserves; check inflation and ensure reasonable positive real interest rates, to protect the large mass of middle-class savers. International capital flows, which are as much about fundamentals as about the Iqbal — the credibility and charisma — of the central bank, responded well to his strategy for stability with fundamental reform.

Job specific technical brilliance and international standing matters

Rajan is the first RBI governor to came to the job with considerable experience in international finance (in the IMF) and even more significantly, a long spell in American academia, in the same area. To the billionaires who make the markets move, Rajan is a familiar face, with a track record of original thinking and practical foresight. He is best known for disagreeing with mainstream economists and foretelling the 2008 financial meltdown.

Rajan’s exquisite symphony- the “Dardnama” (book of pain)

In India, his legacy is the exquisite symphony, he wrote, of caution mixed with big-bang reforms. On interest rates, he was consistently cautious. His mantra was that flooding the economy with cheap money is not a quick-fix for growth. Instead, it can spark off high inflation, as in Brazil.

To the common man, this resonates well with the millennium’s continuing conundrum of jobless, inequitable, high growth. There are no quick fixes for these flaws in today’s post-industrial, service-oriented growth model. Rajan had no choice except to focus on keeping inflation low; preserving the real incomes of the disadvantaged who don’t have the luxury of inflation-indexed incomes and pushing banks and industry hard to become competitive.

His historic big reform was break with the past and publicly finger banks that had lent inefficiently, destroyed capital and most likely enhanced corruption — given the magnitude of bad loans accumulated by them since 2011.

He shone a bright light on the dodgy bank loans overburden- shockingly high at more than 12% of bank assets and 4% of GDP, rather than keeping them hidden under furtive, refinance Ponzi schemes. He was likened by “incremental reformers” to a bull in a china shop — pulling down both fraudsters and unlucky entrepreneurs with equal ferocity.

Admittedly, big-bang reforms shake up the cozy status quo and inflicts pain. But if followed through with decisive surgery, as Rajan recommended, it could have created sustainable wealth, in the medium term, rather than slowly bleed the financial system till it collapses, as happened in the developed world in 2008.

“Big bang” reforms too disruptive for India’s political economy

Will there ever be another Rajan as RBI governor? More importantly do we need another Rajan, given our political economy?

India is a conflicted society — at once eulogizing “savants” like Rajan, and yet shrinking away from the ripples they create in the village pond. It takes a lifetime of work in India to play the system harmoniously. Rajan came before India was ready for him. So while we may not be able to digest a Rajan today, there is unlikely to be a shortage of “suitable” talent. But the real pity is — why have we tried to “fix” a system that is not broken. Why not let the good work continue?

Tough global headwinds for the new Governor

head winds

Grapic credit: janeaustenslondon.com

The irony is that by letting Rajan go in September this year, the government will actually be cementing his “rock star” legacy. The second half of 2016 is blighted by uncertainty and will be hell for the new governor. First, is the near-term question mark over Brexit on June 23. If the “Leavers” win, Europe is surely in for turbulent times. But this may not actually happen, as the British are far too practical to be brash and emotional.

Second, even without a Brexit, the economic outlook is gloomy. Protectionism is growing and geopolitical instability is getting worse. These are fertile grounds for a flight of capital to safety and away from emerging markets like India. A tightening by the US Federal Reserve in the second half of this year may convert the capital flight into an outward-bound tsunami, severely denting our foreign exchange reserves and importing instability.

Oily silver linings and political compulsions

vote 2016

India’s largest state-Uttar Pradesh, votes in 2016: photo credit: teluguflavours.com

The only good news is that oil prices are likely to remain low. The low lead time for the mothballed 500-odd oil fracking rigs in the United States to return to work ensures that any uptick in price beyond $50 will deliver a supply response. Saudi Arabia, with nominal production costs, a deficit budget and a deficit current account and a proposed public listing for its oil company, is unlikely to rein in production or oil revenue. But low oil prices also depress incomes in oil-producing countries, which is bad for Indian exports and disastrous for inward remittances — that are largely dependent on the Gulf countries remaining lucrative employment sinks for Indian expatriates.

Low growth potential in the coming years, combined with the domestic compulsions of the largest state election in Uttar Pradesh in 2017 and three smaller states and a national election in 2019, are likely to strain the fiscal discipline, which the finance minister has assiduously built up since 2014. Rajan was lucky. But had yet to be “Indianised”. He would have got there. But time ran out.

Job description for applicants

queue

India financial leadership job vacant- only the best need apply: photo credit: blogs.wsj.com

Needed an RBI Governor with the political acumen to align with the government’s compulsions. Must be able to quickly improve the well-being of voters. Must also have the economic guile to minimize the resultant damage caused by politics to the economy. Must have his finger on the pulse of Bharat; the experience of having walked this tightrope earlier and the good fortune of being lucky. Must be able to strike practical deals — with big defaulters to ensure that capital starts getting rolled over; with banks so that interest rate cuts are passed on to borrowers; with the government so that Rajan’s “dosanomics” inspired efficiency enhancing incentives are carried forward: cut red tape and discretion in licensing of financial intermediaries; keep interest rates positive in real terms; exercise forensic oversight over banking discipline. Must be reconciled to the macro-economic ball being carried mostly by the government. Must have the access and ability to discreetly warn the government against scoring self-goals.

Adapted from the authors article in The Asian Age, June 19, 2016 : http://www.asianage.com/columnists/does-rbi-needs-political-governor-511

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