While Raghuram Rajan is still concerned about price increases, Modi’s political base is not. Rajan’s dilemma is to decide if industry’s need for lower rates outweighs concerns over inflation
Few central bankers in emerging markets have been as internationally lionised as Raghuram G Rajan of India.
Rajan, the Governor of Reserve Bank of India, has been honoured with awards this winter for his role in helping to bring momentum back to the country’s economy. His unexpected interest rate cut on Thursday helped strengthen emerging market stocks around the world.
At home, the view is less favourable, as Rajan finds himself caught in a political struggle. The coalition of Hindu conservatives and small-business owners who form the political base of Prime Minister Narendra Modi want deeper rate cuts and other policies to help borrowers and stimulate economic growth. Rajan’s critics contend that he has been so focused on reducing inflation that he has not paid enough attention to tumbling world oil prices or the heavy debt burdens of many Indian companies.
“He believes the best way to reduce the temperature of a patient is to kill him,” said Subramanian Swamy, the chairman of the strategic affairs committee of Modi’s party and a former commerce minister and law minister.
The situation reflects Rajan’s bigger dilemma. At 5%, inflation in India is high, compared to the rest of the world. But it is low enough by India’s standards that political support is splintering over further action to address the issue. While Western-trained technocrats like Rajan are still concerned about price increases, populists and businessmen in Modi’s political base are not.
At the same time, economic growth, which is expected to reach 6.4% this year, looks robust by Western standards. Even so, growth is not enough to satisfy many of Modi’s backers, who promised the economy would spring forward if freed from heavy government regulation and taxation. They now want the central bank to help the process by stimulating lending.
In an hour-long interview on Thursday at the Reserve Bank’s headquarters overlooking Mumbai’s financial district, Rajan said that he was not feeling pressure to change the direction of monetary policy. He described a harmonious working relationship with Modi’s top economic policy makers. “We completely understand each other,” he said.
Rajan defended his decision not to lower interest rates at his last monetary policy review on December 2. While oil prices had already fallen considerably by then, he said there was no way to foresee the abrupt plunge that followed, or to pass judgement on how long prices would stay low.
In a news release on Thursday, Rajan made such a judgement, saying, “Crude prices, barring geopolitical shocks, are expected to remain low over the year.” He reduced the bank’s main overnight loan rate by a quarter percent, to 7.75%.
Despite the move, Madhav Nalapat, a Manipal University professor with close ties to the conservative wing of Modi’s Bharatiya Janata Party, predicted that the party’s conservatives would remain deeply unhappy with Rajan, a holdover from the previous government.
“He’s good for Wall Street,” Professor Nalapat said. “He’s not good for our Main Street.”
The acrimony that has greeted Rajan’s slowness to reduce interest rates is symptomatic of why India in particular has tended to tolerate more inflation and of the particular challenges facing central bank leaders in emerging markets.
Many companies in India are heavily indebted and are in favour of rising prices, which make it easier for them to afford fixed monthly payments. Compounding the anger is that Rajan has interpreted broadly his mandate as the country’s top financial regulator as well as monetary policy maker. Rajan has repeatedly urged the country’s mostly state-owned banks to step in and replace management at struggling, indebted companies, instead of waiting for them to fail and default on loans.
He has also insisted that banks start requiring the founders and controlling shareholders of big companies to provide more collateral and give personal guarantees for large bank loans extended to their businesses. That has set off considerable indignation in India’s business elite, which has periodically been able to persuade state-owned banks to expunge debts during hard times, sometimes while retaining their holdings in the same companies. But Rajan, a former chief economist at the International Monetary Fund, said that he had no plans to relent.
“If they do take the risk, they should pay the costs of taking that risk, rather than benefit when that risk pays off but shove the cost on somebody else when it doesn’t,” he said.
Another criticism is that Rajan did not try to reverse the rupee’s steep fall against the dollar, which occurred in the summer of 2013, before he took office in September of that year. This has meant that Indians who had borrowed dollars overseas need more rupees to repay their debts. The central bank has even been intervening in currency markets in ways that tend to prevent the rupee from rising against the dollar: spending rupees to buy more dollars for its foreign exchange reserves.
Rajan defended this move, saying that India needed to rebuild its foreign exchange reserves, which had been depleted during the rupee’s rout in 2013. He also noted that because the rupee had been steady against the strong dollar of late, it had generally been rising this winter against most currencies.
The job of governor of Reserve Bank of India is a strange hybrid, a holdover from British colonial rule, which ended in 1947, with the checks and balances of democracy grafted on.
Unlike the practice at the United States Federal Reserve and many other central banks, where interest rate changes are voted on by a committee, such decisions in India are the personal responsibility of the governor, although he may consult with others. The Reserve Bank also has an unusually broad array of regulatory powers, many of which are not subject to judicial review. It oversees bank licensing, bank regulation, bond trading and consumer protection.
But the central bank governor has less independence, at least on paper. The governor may be dismissed and replaced by the finance minister, who may also order the governor to make an interest rate change, although the order must be issued in writing. Because either move would be highly contentious, finance ministers have refrained over the years from exercising these powers.
Some conservatives around Modi want to see Rajan removed. Swamy, who was a president of the Janata Party before its merger with Modi’s party, predicted on Thursday that Rajan would someday be forced to resign. “I don’t know why they kept him; they didn’t even appoint him,” he said. “He was appointed by the last government.”
But Swamy acknowledged that Rajan retained the strong support of the finance minister, Arun Jaitley, a long-time pillar of the New Delhi establishment. Another friend of Rajan, and his former colleague at the IMF, Arvind Subramanian, became the government’s chief economic adviser in October.
Rajan brushed away questions about political tensions sounded. He sounded wistful only once during the interview, when he explained why he ran half-marathons. “I have never run a full marathon, and my wife will not let me run one,” he said. “She says that’s tempting fate.”