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Thursday, August 8, 2013

Good For The Country – Will It Also Do Good to Dr. Rajan?


Dr. Raghuram G Rajan, Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago’s Graduate School of Business and currently the Chief Economic Advisor to the Govt. of India—who, in 2005 vide his paper, “Has Financial Development Made the World Riskier?” that was read at a function convened for honoring Alan Greenspan, argued that “disaster might loom” in global financial markets, which was, of course, summarily brushed aside by Lawrence Summers but later turned out to be true—has been appointed by Govt. of India as the governor of Reserve Bank of India for a term of three years. He will succeed Dr. D. Subbarao on September 4 as the 23rd governor of RBI.   

Dr. Rajan’s appointment has been greeted with all round enthusiasm, for he brings to the chair of governor deep economic insight and abilities that he had accumulated over the years as  Professor at Chicago University receiving the inaugural Fischer Black Prize awarded by the American Finance Association for contributions to the theory and practice of finance by an economist under age 40, as the  youngest-ever Chief Economist at the International Monetary Fund (IMF), as Economic Advisor to the Prime Minister of India, as member of the Advisory Board of the Comptroller General of the United States, as a senior advisor to BDT Capital, Booz and Co, and as a member of the international advisory board of Bank Itau-Unibanco, etc. Indeed, Prime Minister richly deserves to be complimented for having chosen a well-fit intellectual to steer the financial system of the nation, particularly when the economy is on its South-ward journey. 

At 50, the young governor of RBI, true to the spirit of an academician driven by intellectual brilliance, and absolute honesty, immediately after the break of the news, reacted thus:  “We do not have a magic wand to make the problems disappear instantaneously, but I have absolutely no doubt we will deal with them.” But interestingly, the Forex market reacted to the news of his appointment encouragingly: Rupee, after hitting an all-time low of 61.80 recovered to 60.77 against dollar.

One thing is for certain: Dr. Rajan has the requisite wherewithal to steer the economy that is passing through a rough patch—GDP is down to 5.3%, inflation is at 5.6%, fiscal deficit stood at 5.2 as at the end of fiscal 2013, current account deficit reached a crisis stage at 4.5% of GDP, Rupee, having already lost about 20% against dollar is touching new lows every day,  investor sentiment is down, and above all, the country is on to face general elections soon, which means profligacy at its height, if one has to go by history—out of woods.

Although for a greater part of his life he is outside India, Dr. Rajan is fully aware of Indian economy and what ails it. For instance, he once warned India not to get carried away by the “straight line extrapolations by Goldman Sachs indicating that India is destined to become a great economic power” for he is only hopeful that “with right policies and some luck, we will become a middle-income constitutional democracy in my lifetime”, and at the same time he is also afraid that “inaction coupled with bad luck could make us an unequal oligarchy or worse, far sooner than we think” and perhaps the revelations of the recent past are a testimony to his intellectual interpretations. 

His awareness of Indian financial system well reflects in the far reaching recommendations made by the Committee on Financial Sector Reforms under his Chairmanship. Intriguingly, the Committee recommended that RBI should have a single policy focus: Low, stable inflation, for “by trying to do too many things at once, RBI risks doing none of them well.”  In other words, what the committee meant is that RBI should not dabble around managing inflation, managing exchange rate, and even pursuing economic growth. Indeed Dr. Rajan observed that once the Central Bank achieves a targeted inflationary rate, all other macroeconomic indicators automatically fall in line with that inflation rate. It is of course a different matter that in the changed economic context, this theoretical dictum is being challenged even by the West—Central Banks of the US and EU are now pursuing both GDP growth and inflation rate simultaneously. Even in Japan its Prime Minister is aiming growth in GDP through monetary policy.

Dr. Rajan once observed: “many of the infirmities of public sector banks are a result of their strong links to the government. For example, their technological backwardness has to do in part with the difficulty of procurement in a bureaucratic organization, especially when an attempt to speed up procedures results in a vigilance enquiry. Their poor track record on NPAs has partly to do with political interference with the lending and recovery process. Therefore, reforms have to look at ways of weakening that link.”     

“For small and underperforming PSBs”, he advocated “privatization or consolidation with a well managed PSB. For large PSBs, a first step might be governance-reform—expanding the board’s responsibilities to include the appointment and compensation packages of the top officers of the bank, bringing strategic investors …and allowing minority shareholders a greater say in the appointment of directors.” He also said once: “I think the old RBI policy of not allowing corporates banking license was good one. I still stand by that…”

Intriguingly, his immediate challenge will be: to decide upon the applications from corporate houses lying in RBI for licenses to establish banks.  Will the new governor, by any chance, work for disinvestment of small/not-well-functioning PSBs and in the process encourage corporates to takeover some such banks? Or, will he nudge them to be strategic investors in existing banks so as to freeing at least some PSBs from the stifling burdens imposed by the government? Will he also encourage foreign direct investment in ARCs? After all, these are the questions for which some one has to find an answer and for certain Dr. Rajan is best equipped. 

He is an intellectual with strong views of his own. For instance, he once wrote: “We typically regulate in the midst of a bust... The temptation will be to over-regulate … only to liberalize excessively over time. It would be better to think of regulation that is immune to the cycle.” Indeed, that is what Indian financial system needs today: someone with academic rigor and intellectual honesty to put in place a well structured regulatory mechanism that ensures safe journey of Indian banking system that is right now not all that sound. But the big question is: will he, as the RBI governor, be able to practice what he has been all along advocating?

Intriguingly, he is taking charge of the RBI at a most turbulent time when the relationship between the Central Bank and the Ministry of Finance appears to be not all that hunky dory. Secondly, he may have to antagonize the power centers with which he worked so closely till recently while attempting to put in place new regulations that effectively distance PSBs from the political bosses and make them really accountable to stakeholders—all in the interest of making them sustainable. 

The other big challenge is: Will he as governor of RBI stay focused on inflation alone? Simply put, will Dr. Rajan bite the bullet?  There are of course, subtle pointers—such as his recent reaction to the falling currency and the measures initiated by  the RBI being highly measured— that make one believe that he will pursue his intellectual dictates. But then, will the Indian political bosses let Dr. Rajan pursue his independent course chosen by the economic dictates?

That aside, what one is more worried for him is: he, in the process of dabbling through the maze of Indian political economy, may have to sacrifice his research interests. To that extent, he might be left behind in the race for the Nobel. If it happens, that would be pretty disheartening.

Let us hope for the good of both—India and Dr. Rajan!  


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