Correcting the fault lines

Written by Madan Sabnavis | Updated: Aug 8 2013, 08:04am hrs
The appointment of Dr Raghuram Rajan as the Governor of RBI does not really come as a surprise but certainly ends speculation on the issue. The obvious question that arises is whether or not there will be change of stance in monetary policy once he takes over and, as a corollary, will the solutions be any different given the multiple conundrums we face on growth, inflation and currency.

First, the choice of Rajan appears to be more on the global lines where the Bank of England has appointed Mark Carney from Canada. We have opted for this route as Rajan brings with him a lot of experience from the West, especially the IMF, and has the reputation of the one who saw the crisis coming. The fact that we are exploring options of raising funds from international markets is pertinent here as he could steer the ship in this direction. This is a big advantage for us too when we talk of Basel III and banking regulation in India at a time when the entire system is under various pressures imposed by the new regulatory regime.

Unlike Carney, Rajan has the added advantage of having worked with the PMO and the finance ministry and hence understands what goes on at the ground level to better appreciate how various segments are affected by policy measures. This is important because Indian banking has different priorities given the focus on inclusion, which is not the case in the western countries. Further, the fact that he has studied and authored an entire report on financial sector reforms indicates his expertise in all areas.

The next question is more speculative in nature on how he sees the economy going and the kind of measures that would be taken. On the face of it, so far, the CEA has been in consonance with the moves made by RBI and hence there has never been any overt disagreement on the approach taken by RBI. Therefore, one may expect continuity in approach in general. So far, RBI has a priority list of currency, inflation and growth in the pecking order. Will this change This could be possible because there are evidently multiple views even among economists on what should be the main priority. And also it is quite possible that conditions could be different in September when he takes over in which case it could be a no-brainer.

Assuming the present situation prevails, can anything be done differently on the currency RBI along with the government has covered virtually all possibilities. Measures have been invoked to curtail imports, while the government has worked to increase exports. RBI has curbed the speculative routes to influence the rupee by tightening liquidity. More elbow room has been provided for higher ECBs and FIIs flows (along with Sebi) while the government has done its bit on the FDI front. So, it looks like all options have been covered that also includes direct intervention where our reserves have been drawn down too since April. Can anything more be done Probably not, unless the new RBI Governor takes a view that the rupee is not properly valued presently and should be allowed to gravitate towards a lower number of, say, R65. That would be self-fulfilling. But, at any rate, irrespective of who occupies the position, the rupee has to be brought under control or else it could retard the flow of foreign funds, which is but natural when the currency is considered to be weak.

On the issue of growth versus inflation, Rajan could have a different view. The ministry of finance has felt often that we should change gear and move towards growth and not get obsessed with inflation. While the CEA has not taken this stance, this view could get a prominent place in the scheme of things provided there is conviction. This can be a change of stance where we accept a higher inflation rate on grounds of it being structural in nature and pitch for growth. Hence, it could become a valid possibility and, theoretically speaking, there is nothing right or wrong in either of these stances, because when there is a tradeoff, the Governor has to choose the line of best fit in this scatter graph, which, in turn, will guide the market. Since we have been living with low growth and high inflation in general, there are expectations that the stance will change. It may or may not work, but still a change could be worth experimenting with.

Thus, Rajan will actually be taking over at a time when the economy is in a difficult state. For three years now, growth has been down, and inflation not really at a comfortable level. This would not have been an issue in the past, but after being used to 8% growth number with visions of 10% growth being spoken of, 2 or more likely 3 years of low growth is hard to digest. Expectations from RBI have been high and while RBI has lowered rates, banks have not followed suit to the same extent, which creates another set of problems for the Governor. In fact, another task will be to ensure the stability of the banking system in the midst of high NPAs and restructured assets and an economy that is sliding downwards. Add to this the challenge of banks adjusting to the new capital framework, banking regulation and supervision becomes as important as monetary policy.

The real point of interest would be of any change of stance which can possibly turn things around. We normally tend to personalise such policy priorities which may be interpreting more than what may actually be. Normally the approach is of the central bank as an institution that is driven by members of the institution rather than a single view. Nonetheless, it is still interesting to formulate conjectures as the market is always looking for the same.

The author is chief economist, CARE Ratings.

Views are personal