India’s central banker Dr Raghunath Rajan is to leave his post after completing a three-year term in September 2016, to return to academia in the United States. It will be the first time in 24 years that a term of the Indian central banker has not been renewed by the government. Dr Rajan took over in 2013 when India was reeling from a mini macroeconomic meltdown when the current account deficit was touching 5% of GDP on falling demand for Indian exports and a rising import bill due to the barrel of Brent crude touching $115. His reputation calmed investor’s nerves and allowed stability in the rupee which had seen a drastic decline against world currencies a few months prior. Unlike his tight-lipped predecessors, Rajan was liberal in making his views public on a range of issues from structural reforms needed for prime minister Modi’s “Make In India” initiative to questioning Indian GDP numbers to rising religious intolerance. His main aim as a central banker was to keep India’s historically high inflation in check.
Described by many noted figures in the financial world as a “rockstar banker” best known for predicting the 2008 financial crisis during his term as chief economist for the IMF, news of his departure had articles in local papers and editorials in many Western publications such as Bloomberg and The Financial Times, pointing the figure at India’s government for playing politics. Many have questioned the future of reforms and growth in India, currently (despite issues with official numbers) the world’s fastest growing economy.
It is abundantly clear that the Modi government and finance minister Arun Jaitley did not get along with Dr Rajan. However, was this a disagreement in policy or a political vendetta? It should be known that Mr Rajan was the chief economic adviser to previous prime minister Manmohan Singh before being appointed as the central banker. The Modi government does have a track record of removing bureaucrats who were seen close to the previous centre-left regime. The government’s case is also not helped by one of its senior members in the Rajya Sabha, Subramanian Swamy viciously attacking Dr Rajan below the belt by questioning his Indianness owing to him being a green card holder. As things stand, Dr Swamy has also attacked Arvind Subramanian, Rajan’s likely successor on the same issue. Unlike Mr Rajan, the Modi government was quick to defend him. There have also been other theories for his removal. Rajan by forcing India’s banks to declare bad loans as non-performing assets forced many corporates houses to conduct a fire sale of their assets to pay back the banks and avoid being labelled as willful defaulters. Therefore Rajan made many powerful enemies from supposed champions of industry and rumbled the politician-industrialist nexus. The final theory doing the rounds is that Rajan wanted a reduced second term due to academic considerations but the government refused to oblige.
Such theories are wide off the mark as are these sensationalist headlines (from respectable publications no less) putting India’s growth in question. The fundamental fact remains that many in the Modi government felt that Rajan was too conservative in not cutting interests rates at a time when industrial inflation was under control. Rajan always a hawk was going to be out of place in the dovish Modi government. Most will agree that Mr Swamy is a loose cannon who has extreme social views. However, he does hold a PhD in Economics from the Harvard University and has taught at the institution till 2011. Bloomberg’s article comparing him to Donald Trump is comparing apples to oranges. Dr Swamy’s views on the Indian economy do carry weight. He is also a noted anti-corruption crusader who has dragged the Gandhi family into the courts over the National Herald case along with dozens of regional politicians. Unlike Trump and rhetoric, Dr Swamy has acted on many of his convictions. It was Mr Swamy’s merciless attacks on the Gandhi family which allowed the budget session to function (passing many reforms such as the bankruptcy code) after the previous monsoon and winter sessions were washed out when the Congress party decided to disrupt parliament. The Modi government has realised if it to pass reforms in the upper house, Dr Swamy despite his odious social views is a necessary evil.
Ignoring Dr Swamy’s personal taunts towards Dr Rajan, he was of the opinion that despite inflation being low primarily due to the fall oil prices, Rajan refused to cut interest rates, especially for small businesses. This is a view shared by former Indian finance minister Dr Yashwant Sinha who has also had a stab at Dr Rajan in the past. The Modi government was elected to power on the back of promising jobs to India’s youth who are rapidly joining the workforce. India’s recovery from the 2013 financial crisis has been a jobless recovery. Smaller businesses are the major drivers of job growth in India and a fundamental bedrock of Modi’s Bharatiya Janta Party (BJP). One could argue if political considerations were made, that rather than Rajan’s NPA actions aggravating corporate entities, it was his actions (or lack of) on interest rates which hurt the BJP much harder politically.
However, if one is to consider a purely economic view, India’s current rate sits at a five-year low of 6.5%. Inflation is at about 5.76% and edging up. A simple look at statistics might suggest Rajan was right in not cutting aggressively. This would be a mistake. Unlike many countries in the West or even the developing world, India’s CPI basket is weighed up to 40% by food. The country has suffered a drought for the past two years, and the price of pulses (a source of protein for the masses) has skyrocketed. The inflation rate excluding food remains stable at around 5%. So the question arises, just how much can keeping rates high achieve in combating food inflation? Unlike the West, India has an incredibly poor food distribution system with multiple layers of middle men jacking prices, operating in the informal sector. The situation is made worse when monsoons fail and demand heavily outstrips supply. In such a scenario there are limits to what any central banker in India can do. Indian economic history tells us rate cuts have an extremely limited impact on food inflation. The service and industrial sectors are held hostage to the monsoons. Sectors such as steel facing the onslaught of cheap Chinese imports are left paying a steep price for credit. It would, therefore, be prudent for India to separate food from the CPI basket and have a special food banker who can use India’s $360 billion forex reserves to import food dynamically without government interference to keep prices range bound.
Due to the NPA crisis, India’s state sector banks are not passing along the full value of the rate cuts to their customers. Dr Rajan admits to the same. Of the 1.5% he has cut in his tenure, only 0.5% have been passed along for home loans. State banks are not willing to lose depositors at a time when they need to bolster their balance sheets to tide against the rising bad loans. However, not cutting deeper is unfair to Indian private banks who form 30% of the banking sector and have been a lot more responsible in their lending practices. A lot of these bad loans were made during the previous regime from 2011-mid 2014 when reforms stalled. The government then, to boost growth turned on the taps and forced state-owned banks to lend blindly which boosted crony capitalism. If one were to dwell in the realms of conspiracy theories Dr Rajan who was the chief economic adviser to Dr Manmohan Singh in 2012 should surely have raised his voice publicly to make the world aware of this malpractice? Maybe he would not have to clean the mess if it was not created in the first place? Did Dr Rajan keep quiet to get the coveted post of a central banker?
Another function of leaving rates unchanged or increasing them is to control the currency. The role of the India’s central banker is to keep the currency stable within range. India’s currency since the Modi government took over two years ago has drifted from Rs 60 to the US dollar to currently Rs 68. Considering the fall in the value of other emerging market currencies, India has held its ground. Dr Rajan must be credited with aggressively boosting India’s forex reserves which stand at $360 billion. Just like other emerging markets India’s exports have declined as demand has been sluggish. However, unlike other emerging markets FDI to India has rapidly increased more than compensating for the fall in exports. Mr Modi has lifted many barriers and relentlessly travelled to ensure India sticks out for investment among its developing peers. India’s current account deficit was 0.1% in the Jan-Mar 2016 quarter, and the country might run a surplus by the end of the year. Furthermore, the government has maintained fiscal discipline and raised indirect taxes to bridge the budget deficit. From 5% of GDP in 2012-2013, finance minister Arun Jaitley’s 2016-2017 budget focused on efficiency and bringing it down to 3.5% of GDP. There were no major populist measures as tax bands remained static. Based on the above statements, two things are clear. One, India is in a very strong position macro-economically (the individual replacing Dr Rajan will have a smooth introduction to the role). Secondly the government must get its due share of credit.
Looking at reforms, many fear that the NPA crisis will not be properly addressed once Dr Rajan departs. Dr Rajan has commented that he expected the NPA crisis to be contained by March 2017 when state-owned banks are expected to return to profitability. That is just two quarters from his resignation in September 2016. Clearly, the amount of media scrutiny will mean any replacement will see Dr Rajan’s reforms to their natural conclusion. Furthermore, the Modi government has acted on the source of the rot. The newly passed bankruptcy code aims to banish crony capitalism and make India’s corporate houses pay back their dues to banks or have their assets seized within 180 days of default. Several smaller state-owned banks prone to corruption have been merged into the larger State Bank of India (SBI) to boost transparency. The aim is to have 5-6 major state-owned banks covering all parts of the country. A special willful defaulters list has been created, and the Securities and Exchange Board of India (SEBI) has passed a law to ban said defaulters from raising capital via the equity markets. When it comes to structural reform, the government after elections to the upper house on 11 June 2016 feels it has enough numbers to pass the crucial GST tax reform. Government sources have said they will introduce it on the first day of the monsoon session and put it to a vote. Just after Rajan’s exit was announced the government eased norms in key sectors ranging from pharmaceuticals to defence to further boost FDI. These do not sound like the actions of a government shying away from reform or hand in glove with corporate entities. The markets clearly agreed as reflected when the Sensex after an initial dip rose 241 points on the back of strong monsoon spreading across the country and the liberalised FDI measures. A strong monsoon (reducing food inflation) and passing the GST bill are going to be much bigger endogenous trigger events than Dr Rajan stepping down.
Finally, one of the reforms in the Finance bill of 2016 was to set up a monetary policy panel consisting of 6 members, similar to the system in the United Kingdom. It would be comprised of 3 members of academic background chosen by the government and three chosen by the central bank with the governor holding the deciding vote in case of a tie. Prior, the governor of the central bank held a veto on interest rate matters with others being in a purely advisory capacity. Considering the diversity of opinion at India’s central bank and the tendency of the Indian government nominees to vote along with the views of the finance minister, the odds were always extremely high that somebody like Dr Rajan who stood out like a sore thumb with his conservative stance would be outvoted. Rather than being outmanoeuvred in public, it might just be that he decided to quit. His replacement is going to find his/her powers clipped.
Some in the Western media will be prudent to be neutral when writing about India and the Modi government in particular on the economic front. It is no secret that outlets such as The Economist (then owned by the Financial Times) published an editorial column advising Indians to vote against Modi in the 2014 Indian general election. They do not like the social dimensions of his regime, a fair and principled stance. However, it is deeply unfair to their readers that they are questioning the reforming credentials of the Modi government. The Indian economy is very much a case of glass half full than empty. It is a work in progress. All said and done Mr Rajan has done a credible job as a central banker. He must be thanked for his efforts. But, in a country of a billion people, there are many competent and willing men and women to take his place. Ultimately Dr Rajan’s conservative approach to rate cuts led to his departure as India’s central banker. The Modi government wants a dove, not a hawk and its views on policy must be respected without wild speculation.