How is India's Rajan Leaving a Good Thing?

June 27, 2016Indiaby East Asia Forum

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India's Rajan stepping down did not happen to rave reviews.

The surprise announcement last week that Raghuram Rajan, Governor of the Reserve Bank of India, was stepping down sent shockwaves around the world. Rajan, a brilliant academic who came from the University of Chicago to take up the appointment under the Singh government, was credited with stabilising the economy and turning inflation around. He is an outspoken champion of both economic and social reform. When push came to shove, he chose to go.

Rajan is rated by some as the world’s best central banker. His departure raises doubts about the Indian government’s commitment to structural reforms, as well as India’s position as a haven of safety amid the troubles in other emerging markets.

Famous for calling the global financial crisis before it hit, Rajan brought a clear and articulate mission to his job at the Bank. Tighter monetary policy as well as a decline in commodity prices helped tame inflation, enabling the central bank to cut interest rates by more than 1.5 percentage points since the beginning of 2015.

However, for Rajan inflation was not the only target. He asked the banks, whose lending decisions have been closely tied to politics, to clean up their books. He was an outspoken critic of the government’s management of social issues, particularly crony capitalism, police corruption and religious violence. He did not define his remit narrowly, arguably necessarily, where state-owned banks and their murky links to politics still dominate the Indian economy,

But who can imagine Janet Yellen in the United States, Haruhiko Kuroda in Japan, Zhou Xiaochuan in China or certainly Glenn Stevens in Australia claiming such ground?

When Rajan took over the Reserve Bank, the economy was declining at an annualised rate of 2 percent, consumer prices were soaring at 9.8 percent, the rupee was down 16.6 percent from the previous year and the current account deficit was estimated at 4 percent of GDP.

He is now leaving an economy that on current measures is growing at a rate close to 8 percent, with inflation down to 5.8 percent, the rupee down only 4.7 percent from its level a year ago and the estimated current account deficit at about 1.3 percent of GDP.

Having inherited Rajan from the Congress government, Prime Minister Narendra Modi and his Finance Minister, Arun Jaitley, gave him maximum support and space to implement the plan he’d announced after taking over in September 2013. The National Democratic Alliance government also took the flack for Rajan’s decision to not let interest rates decline more rapidly, as many demanded — including those like the combative Subramanian Swamy, close to the government’s leadership, who accused Rajan of wrecking the economy.

That Rajan succeeded in restraining inflation was partly due to plain good luck and partly to the staunch support he received from the government in maintaining tight fiscal discipline. The government also backed down twice in the face of opposition by Rajan, first to the Financial Sector Legislative Reform Commission’s recommendations and, second, to the creation of an independent public debt office in the Ministry of Finance. What more could a government do to retain this exceptional talent? Why did Modi withdraw his support over the past few months?

The economic reason may have been government worries about the weakness in bank lending. Bent on cleaning up the banks, Rajan arguably neglected the priority the government attached to boosting investment and jobs through credit expansion. However, the more plausible reason is a fracture in confidence in the governor stemming from his attempt to combine the role of a senior civil servant with that of a public intellectual. In addition, the balance, in the end, proved too uncomfortable for Modi’s political base.

Rajiv Kumar, who’s written critically of Rajan’s pushing the envelope in this context, now turns the spotlight in this week’s lead how the Modi government more generally has managed the economy in its first two years.

‘The good news’, says Kumar, ‘is that the economy has successfully weathered two years of subnormal monsoons and anaemic global economic growth. India has firmly emerged out of the group of the “fragile five” in which it found itself in the second half of 2013’ to become one of the fastest growing economies in the world. However, while the indefatigable Modi has undertaken a great number of incremental reforms, he has yet to address the main job of structural reform.

‘Major sectors like agriculture, education, health, public sector enterprise management, judicial reform and a much-needed overhaul of the administrative machinery have remained virtually untouched’. So too Kumar might have added, apart from Rajan’s brave attempt, has the central problem of reforming the banking system.

Perhaps these reforms are seen to be too politically risky and best left to the next term, Kumar suggests. Modi’s strategy seems to be to try and kick start investment and extract the maximum possible growth from improvements to governance, while leaving the more radical reforms for later. However, the undertow of resistance to letting the market does its powerful work in India remains strong.

There are also concerns about whether India’s growth numbers are being fudged, as Alok Sheel has examined in forensic detail.

The Modi government’s choice of a new Reserve Bank governor will be of more than ordinary interest to markets and strategic analysts alike. India’s growth trajectory is by no means assured. It still has to tackle the challenge of generating the minimum 10 million jobs each year required to absorb fresh entrants to the workforce, and implement radical structural reforms if it is to sustain genuine growth. In addition, that requires much more than fiddling with statistics and playing around at the margins of reform.

Is the Indian economy a pack of cards? is republished with permission from East Asia Forum