Man takes on mission impossible. Reuters/Adnan Abidi
It
would be hard to name a more qualified candidate to take over the
Reserve Bank of India. But despite his long list of career successes,
Raghuram Rajan, who takes the helm in September, may do a terrible
job—though it probably wouldn’t be his fault.
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Why?
Because India’s growth has already slowed to a decade low, the current
account deficit has ballooned, and the currency is suffering from a
massive sell-off. In fact, even as the government announced Rajan’s
appointment, the rupee hit a fresh all-time low before paring its losses to close at 60.77 to the US dollar.
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Rajan,
who became the youngest ever chief economist of the International
Monetary Fund in 2003, has built a reputation as a world-class
economist. His prescient warnings (pdf) about a coming financial crisis in 2005 ruffled many feathers (paywall)
at the last Jackson Hole symposium Alan Greenspan attended as chairman
of the US Federal Reserve. Accolades followed when history proved Rajan
right, and won him a starring role in Inside Job, the Oscar
winning documentary about the 2008-09 crisis. Rajan joined India’s
government last year as the chief economic advisor, a move many saw an
attempt by the finance minister Palaniappan Chidambaram to groom him (paywall) for the central bank job.
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In
Rajan, India will get a progressive thinker with an impeccable standing
both at home and abroad. But India’s political realities may hinder his
potential as an effective leader.
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For
one thing, the government faces elections in less than a year, which
could lead to rampant government spending. Chidamabaram has so far kept a
tight lid on expenses, contrary to the spending binges usually seen in
the lead-up to elections. But with the ruling Congress party weakened by
corruption scandals, the economic slowdown, and public antipathy
towards incumbents, chances are the government will succumb to populist
demands to spend more.
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The central bank will also have to grapple with what the current governor D Subbarao termed as the “impossible trinity”
of monetary policy. It cannot simultaneously maintain free movement of
capital, a managed exchange rate and an interest rate policy that takes
its cues from inflation.
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The rupee may be Rajan’s biggest challenge. The currency has depreciated around 13% in the last six months despite repeated interventions
by the central bank. The fundamental drivers of the weakness—a record
current account deficit and capital outflows—are not entirely in the
RBI’s control. It will also not be able to defend the rupee with direct
interventions, given that foreign exchange reserves are at a three-year
low, which is barely enough to cover imports for about six months.
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The rupee’s fall threatens to stoke inflation.
The consumer-price index climbed almost 10% in June on an annual basis.
Any attempt by the central bank to rein in inflation through interest
rate hikes will hamper growth, and is unlikely to go down well with the
political bosses in New Delhi, especially in an election year.
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The
central bank’s relationship with the finance ministry has been strained
in recent years due to excessive government interference. The outgoing
governor D Subbarao came under fire
for maintaining tight monetary policy despite repeated entreaties from
the government to ease rates to boost growth. His predecessor YV Reddy
also had public disagreements with the finance ministry, as he favored
using rate hikes to cool an overheating economy. Rajan’s ability to
defend the RBI’s turf will depend largely on his relationship with the
government.
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So far, Rajan hasn’t been keen to play politics. A free market advocate, he firmly believes that high government spending has depressed India’s economy. In a column he wrote since taking over as chief economic advisor, Rajan criticized the prevailing economic thinking of the government.
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In addition to more investment, India needs less consumption and higher savings. The government has taken a first step by tightening its own budget and spending less, especially on distortionary subsidies.+
Rajan has also been a outspoken critic of cronyism and corruption, something that will make influential figures in both the government and the corporate world uncomfortable.
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