Monday, June 13, 2016

The Indian Economy under Rajan

This article was first published by the Global Association for Risk Professionals on June 09, 2016; was updated on June 20, 2016; Co-author: Anisha Sircar, Flame University, Pune

Results of the central banker’s first term made a strong case for reappointment to a second

Subramanian Swamy, a Harvard University PhD in economics and a member of the Upper House of the Parliament of India, recently wrote a letter to Prime Minister Narendra Modi. It criticized Dr. Raghuram Rajan, the 23rd governor of the Reserve Bank of India, on many different counts, and urged immediate termination of Rajan’s services, on grounds that the central banker, whose three-year term expires in September, is deliberately trying to “wreck the economy.”

After saying he was open to serving a second term and leaving the decision to the Modi government, Rajan issued a statement June 18 saying he will step down.

Rajan has been generally recognized as one of the most influential and proficient governors of the RBI. He was previously chief economist at the International Monetary Fund, chief economic adviser of India’s Ministry of Finance, and the Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago’s Booth School of Business. He is credited with predicting, early in 2005, the global financial crisis that hit in 2008. He was regarded as someone with international exposure who could anticipate problems and find distinct solutions.

When Rajan assumed office at the RBI in 2013, the economic climate was characterized by a free-falling rupee, touching nearly 70 against the U.S. dollar, alongside rising deficits, high inflation and overall sluggish growth.

Early on, Rajan announced his “Five Pillars of Reform,” inspired by the three “arrows” of the Japanese Prime Minister, Shinzo Abe. The pillars were an effective monetary policy framework that was transparent, credible, clear, and that could be “understood by the broader public”; banking sector reforms to give anybody the liberty to apply and set up a bank at any time; deepening the Indian markets; providing financial services to rural areas; and the creation of a “simpler, cleaner and less value-reducing” mechanism to address financial distress so that lending was rendered easier, faster and more efficient.

Besides delivering on the promises made at the start of his term, Rajan, along with other key decision makers and other factors, helped in ensuring that India has been the emerging-markets nation to withstand a general economic downturn. Other BRICS countries were considerably weakened in the aftermath of the Chinese slowdown.

Furthermore, facing anticipated Federal Reserve tightening, the rupee remained relatively strong. Last year, when the rupee plummeted to a two-year low, passing the 66/$ mark, and Sensex tumbled after the yuan shock, Rajan assured the world that India was in a far better position to weather the volatility.

Downward Inflation
Monetary policy under Rajan has been regarded as far more clear and systematic than its antecedents. According to the new framework, the challenge was to achieve an inflation target of 6% by 2016 and 4% by 2017; that is on target, with inflation now around 5.4%.

Declining inflation has made India a favorable investment destination and paved the way for continual interest rate cuts. However, containing inflation through interest rates has not gone down well with critics such as Swamy, who has called it “disastrous” to the industry, causing unemployment.

In his May 16 letter to Modi, Swamy voiced objections to the shifting of the inflation target from the wholesale price index (WPI) to consumer price Index (CPI). That the move was recommended by an Expert Committee set up to “Revise and Strengthen the Monetary Policy Framework,” and that the committee was comprised of eminent economists and statisticians from such institutions as the Indian Statistical Institute (New Delhi), Williams College (USA), JPMorgan, Bank of Baroda and Nomura Securities, apart from being represented by the RBI, does not seem to matter to Dr. Swamy.

As explained in the committee report, “CPI inflation excluding food and fuel has remained sticky at an elevated level, averaging above 8% and playing a growing role in determining wage and price behavior in India.”

The report also stated: “Shocks to WPI inflation have no statistically significant impact on inflation expectations, indicating that targeting the WPI would do little to anchor inflation expectations”.

It is also contended that private-sector corporate investing has flatlined after peaking in 2011, that the stressed assets may lead to a decline in investment, and that this is a bottleneck that needs to be dealt with by the RBI. “In the last two years,” Swamy wrote, estimated NPA [non-performing assets] in public-sector banks has doubled.”

Bank Provisions
It needs to be acknowledged that the NPAs have accumulated over several years. But, at least under Rajan, the banks have started to recognize these stressed assets and begun provisioning for them. The first step towards solving a problem is to recognize that there is a problem – and that step seems to have been taken.

It is also argued that despite the success so far with inflation, and interest rates coming down, real borrowing costs remain high. And although it has remained relatively resilient, it is not on a strengthening trajectory, which is a cause for worry as it may engender higher inflation in months to come. The cost of borrowing/lending is determined by the banks, and Rajan has been appealing to the banks to pass on the decrease in interest rates to the customers.

Equity strategist Christopher Wood of CLSA, in one of his “Greed & fear” reports, argued that the biggest risk to India’s bond and currency markets would be to let Rajan’s term expire.

Doyens of Indian industry have come out in support of Rajan, urging a second term at the RBI. These are the same industrialists who have kept up pressure on Rajan to reduce interest rates further. So why would they be so supportive of him? The answer is simple. Rajan has “performed.”

Rajan said on CNBC Awaaz as reported June 8, “The announcement over my tenure will be made between now and September 4 when my term ends.” He acknowledged that his “long-term plan is to get back into academics, to teach and to go for research.


Rajan has now ended the suspense, stating the following in an open letter to RBI colleagues that, in large part, defended his record: “While I was open to seeing these developments through, on due reflection, and after consultation with the government, I want to share with you that I will be returning to academia when my term as governor ends on September 4, 2016. I will, of course, always be available to serve my country when needed.”
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