This article was first published by the Global
Association for Risk Professionals on June 09, 2016; was updated on June 20,
2016;
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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