Raghuram Rajan

Raghuram Rajan has taken over as the 23rd governor of the Reserve Bank of India at a critical time for the Indian economy. The situation is so bad that comparisons have been made with the 1991 scenario when India had to approach the International Monetary Fund for a bailout package. The external value of the rupee has plummeted, as indeed has the growth rate, which, at less than 5 per cent, is less than half of what it was during the halcyon years not so long ago. What has not plummeted is the current account deficit — this has been climbing inexorably, essentially on the back of crude oil imports, although Indians’ love affair with gold has also contributed to the deficit.

Rajan is as equipped to deal with financial crises as anyone — not just in India but throughout the world. He has not wasted any time in getting down to business. On the first day itself, he announced a slew of financial sector reforms. Some of these are fire-fighting measures designed primarily to prop up the rupee in the short run. Several of the other policy changes are designed to strengthen the banking sector and more generally the entire financial sector in the country. Some of the measures reflect his basic belief in the ‘Chicago’ style of economics — more reliance on the market and less government interference. For instance, existing banks will no longer have to obtain RBI permission to open new licences, although they will still have to maintain an appropriate degree of presence in rural areas.

He has also stated his intention to reduce the amount of government securities that banks are required to hold so that more credit can flow into the private sector. This will not please the finance ministry since it will increase the cost of government borrowing. Hopefully, the RBI governor will stick to his stand and maintain the autonomy of the central bank. Another important goal that he has set for the RBI is to increase the role of the rupee in international transactions. This will be possible only if financial markets are made more open, and will perhaps involve more steps towards full convertibility of the rupee. We will get to know more about his long-terms intentions later this month when the RBI comes out with its mid-term review of the economy.

His maiden speech has been welcomed by practically everyone. The rupee appreciated sharply the very next day, signalling incidentally that at least some of the fluctuations are due to speculative actions. The rupee has marched up for several days in succession and reached almost 63 to the dollar. Similarly, share prices too increased for three days running, with the cumulative increase in the sensex being quite spectacular. Not surprisingly, the rise in banking sector share prices has been particularly spectacular. The euphoria generated by Rajan’s announcement has been so strong that several commentators, including the chairman of the prime minister’s economic advisory council, have declared that the worst is over for the rupee, and that the rupee will stabilize at its current level.

It would be surprising if Rajan himself believes this. He was refreshingly forthright a few days before he took up his new responsibility when he remarked that he possesses no magic wand, and so could not promise a quick fix to the problems besetting the economy. There is now every hope that the RBI will bring about a more growth-friendly monetary policy. Indeed, the entire financial sector may see a much-needed overhaul. Unfortunately, when an economy is plagued by a variety of diseases, there is only so much that a central bank can achieve.

We should first ask ourselves why the rupee has plummeted downwards so sharply. The government’s favourite explanation is that it was triggered by the fear that the monetary authorities in the United States of America would soon stop the easy money policy since the American economy has shown signs of recovery. While it is true that this apprehension has caused American financial institutions to withdraw funds from emerging markets, this does not explain why the Indian rupee has exhibited the sharpest fall amongst all emerging market currencies. The chief reason for the rupee’s decline is undoubtedly the soaring current account deficit. This, along with the drastic slowdown in the rate of growth, must have caused foreign institutional investors to lose faith in the economy.

Of course, the sharp depreciation of the rupee is itself a partial solution to the current account deficit. Indian exports are now more competitive in world markets while foreign goods have become much more expensive in India. In addition, the government has taken some steps to reduce gold imports. The latest trade statistics do show some improvement — exports have increased while there has been some compression of imports. The trade deficit for the month of August has been the lowest in seven months. There may even be more cheerful news on this score soon. There are fledgling signs of recovery in continental Europe while the US economy continues to improve slowly but steadily. So Indian exporters can look forward to more profitable times in the near future.

Perhaps the more knotty problem is the state of government finances and the deceleration in the rate of growth. The fiscal deficit of the Central government continues to be very high. The finance ministry seems concerned about this. The slowing down of the economy has inevitably meant that the government’s tax revenue collections have also barely increased. So the government has had to cut back expenditure in order to put a cap on the imbalance between expenditure and revenue. Unfortunately, at least some of the cutback has also been borne by plan expenditure, to the detriment of growth prospects for the economy.

Infrastructural bottlenecks continue to act as major constraints. Added to this have been new constraints in the form of problems with land acquisition as well as environmental clearances. Prospects for the manufacturing sector seem very bleak. The services sector has been the main engine of growth for some time. But even this sector is exhibiting some signs of tiredness. Agriculture is expected to turn in a good performance during the course of the year since the monsoon has been good. But, agriculture is no longer the major player in the economy, and so even a high sectoral growth rate will not translate into a reasonable rate of growth in the aggregate.

A government determined to take positive action — for instance by cutting ill-directed subsidies such as on fuel — could make a huge difference. But even in the best of times, this government has not distinguished itself. The chances of it taking hard economic decisions are particularly remote with elections round the corner. So, Rajan’s efforts may well come to nought.