Subbarao had Lehman, Rajan has policy paralysis
That RBI Governor-designate Raghuram Rajan shot to prominence with his famous Jackson Hole speech in 2005 is well known where he questioned then Fed chairman Alan Greenspan’s irrational exuberance, arguing that financial development may have made the world riskier since cheap money was papering over what he later famously called Fault Lines. What is less publicised is the speech Rajan, then an honorary advisor to the government, delivered last year at an update of a festschrift in honour of Prime Minister Manmohan Singh. Apart from lamenting the lack of second-generation reforms, Rajan told the Prime Minister “alarm bells should sound when domestic industry no longer wants to invest in India, even while eagerly investing abroad”, and while castigating politicians for being “even more focused on subsidies and transfers to keep people happy, especially as general elections near”, he spoke of the move from licence-permit-raj to a resource-raj, and the need to be kinder to foreign investors—“they are not the enemy, but a necessity … to fund our spending to the tune of four per cent of GDP”. In many ways, though not in quite the same words, that sounds like an argument made often enough by outgoing RBI Governor D Subbarao: interest rate cuts in themselves will not rekindle animal spirits, the government needs to do the lion’s share of the heavy lifting.
How different will Rajan be from Subbarao, will he lower interest rates to stimulate growth? The answer is complicated since, often, the situation dictates the response—while RBI was ready to lower rates again this time around, the fact that its normal intervention in currency markets didn’t help stabilise the rupee is what determined the latest monetary tightening. Whether that works or not remains to be seen—the rupee was at 59.9 to a dollar when RBI started tightening on July 15 and is 60.81 today though FIIs outflows have slowed from $2.5 billion between July 1 and 15 to $0.5 billion from then till August 5. But this, in many ways, is IMF orthodoxy, and Rajan was the IMF’s chief economist, its youngest chief economist, from 2003 to 2006. Indeed, one of the recommendations in the financial reforms committee set up under Rajan in 2008 was that RBI should formally adopt a low inflation target—once inflation is expected to fall, the report says, RBI should be willing to cut rates so as to revive growth. With the economy in trouble—the Composite Output PMI for July contracted for the first time in 4 years—the government still stumbling out of policy paralysis while, at the same time, passing a Food Security Bill, and the rupee reflecting global investor worries, it is open to question whether Rajan has solutions that are radically different from Subbarao. Given the old IMF prescriptions of monetary and fiscal tightening, in east Asia and now Europe, have been discredited since—the IMF’s current chief economist did a major mea culpa when he published a paper arguing IMF’s short-run austerity policies in Europe probably worsened growth—it is to be hoped Rajan will be more pragmatic since there is little doubt interest rates play a major role in stimulating growth and, in turn, curbing supply-side inflation. Rajan’s A Hundred Small Steps in financial reform is equally important and suggests a Governor in sync with what real reforms are needed, in bond markets for instance. But in the run-up to the elections, if the government is to move towards more spending and worry less about being friendly to investors, Rajan’s room for manoeuvre is certain to be constrained.