When economist Raghuram Rajan was appointed governor of the
Reserve Bank of India (RBI) in early August, the Indian press
went wild. The man who had predicted the financial crisis years
in advance was dubbed a rock-star economist with
photogenic appeal; he was gushed over like a
For a nation which had in just a few years seen its fortunes
turn from long-term double-digit GDP growth forecasts to just
5% growth last year, the media seemed to be saying here
is a saviour. In the weeks before Rajan took up his post
in early September, the rupee went into freefall, losing over
20% of its value in real terms in the span of just three days
in the middle of the month.
As the US Federal Reserves expected move to begin
tapering its asset buying programme loomed, some emerging
markets currencies went into a tailspin, few more than the
rupee. Every day seemed to bring the currency to a fresh
lifetime low against the dollar, even as the RBI scrambled to
prop it up in ways some criticized as counterproductive.
A few days before Rajan became the 23rd RBI governor, the
government announced that GDP had grown just 4.4% in the
quarter ended in June. That led HSBC to slash its forecast for
the fiscal year ending in March from 5.5% to 4%, and for the
following year from 6.6% to 5.5%.
On September 4, the rupee again crept close to its record
low, and Rajan took the helm of the RBI. In his opening
statement he announced a slew of reforms aimed at liberalizing
the banking sector and expanding financial services to the
hundreds of millions of Indians who remain unbanked.
There are so many low-hanging fruit in the economy that
if we only pluck them we can accelerate growth
substantially, Rajan said.
Under the reforms, banks were no longer required to receive
RBI approval for every branch they open, but they were still
required to open banks in underserved rural areas and cities in
equal proportion. He also said the RBI would announce a new
round of bank licences early next year, and would encourage
foreign banks to operate in India as wholly-owned subsidiaries
to foster competition.
Down the line, the RBI would introduce new interest rate
futures contracts, establish mobile payments systems and ease
restrictions on overseas borrowing by banks.
It was a virtuoso display by the former chief economist of
the International Monetary Fund, which drew praise from
analysts and economists as a positive step. The rupee quickly
reversed its downward trend. From over Rs68 against the dollar
it strengthened to closer to Rs62 by September 19, also helped
by the Feds decision not to begin tapering.
In the Indian press, the response was effusive. The front
page of the Economic Times, the countrys top-selling
business daily, featured Rajan mocked up as James Bond, in a
dapper suit and wielding a gun made of rupee notes.
But Bala Balachandran, a professor at Northwestern
Universitys Kellogg School of Management who has known
Rajan for 20 years, says the press has missed the point: a man
of action doesnt carry a gun made of money. It wont
fire any bullets.
Im positive he is doing everything he can
do...but whatever he is doing is a Band Aid solution to a
haemorrhaging problem, Balachandran says. What he
is doing is probably being influenced by the government to
delay this problem rather than solve it deferring it to
a later date to make sure that until the elections, any issues
are stopped temporarily.
Therein, for many economists and analysts, lies the problem
as great as Rajans powers of intellect and
judgement are, it is unlikely he will be able to enact any
major reforms until after national elections in May. This lack
of action has been a constant for well over a year, and is only
likely to crystallize in the coming months, as the ruling
United Progressive Alliance attempts to shore up support ahead
of what is likely to be a bruising fight.
Theres only so much Rajan can do, says
Sumit Ganguly, a professor at Indiana University who has
written books on India. The real issue is that the
government must get to work on a host of issues which it has
neglected for far too long from infrastructure ... to
reducing restrictions on foreign investment to labour
In his first policy review statement, Rajan confounded
expectations by raising the repo rate by 25 basis points to
7.5% and relaxing tightening measures that had been introduced
in July in order to bring more liquidity into the banking
system. He also warned that the Feds decision to delay
tapering was simply a temporary reprieve for India.
Let us remember that the postponement of tapering is
only that, a postponement, he said. We must use
this time to create a bullet proof national balance sheet and
growth agenda, which creates confidence in citizens and
Eswar Prasad, senior fellow at the Brookings Institution,
says Rajan was clearly signalling the limits of what the
reserve bank can and cannot do it can undertake
significant financial market reform, but it must remain focused
on inflation and cannot take on the entire burden of supporting
growth. With GDP growth clocking in at the slowest rate
since 2009, and the wholesale and consumer price indices up
6.1% and 9.5%, respectively, in August, India cannot afford
more inaction. But theres little indication, the
RBIs new vigour notwithstanding, that the implementation
of fundamental reforms will be forthcoming.
We need to wait for elections any new
government will have a mandate for action and thus will be
expected to act after elections, says A Prasanna,
economist at ICICI Securities.
While that remains to be seen the UPA came in with an
electoral mandate in 2009 but did nothing as the economy
faltered under its watch there is some hope.
The Cabinet Committee on Investment has set a 60-day
deadline for ministries to clear big-ticket infrastructure
projects in highways, coal and power sectors. It has so far
cleared over 150 major projects, though they are unlikely to
bear fruit in the economy until the fiscal year ending in March
Investment to overcome Indias notorious infrastructure
deficit will be crucial to economic growth, says Atsi Sheth,
senior credit officer at Moodys. But finding funding will
be difficult. The problem is that infrastructure requires
a lot of investment the government is not in a position
to make this investment, and the private sector is not willing
to make the leap, given all of the uncertainties, she
Parliament has also passed a long-awaited companies bill, a
crucial reform that will bring greater corporate governance and
transparency to business in a country where 80% are controlled
by founders and their families. This summer, the government
opened up telecoms to 100% foreign ownership and eased FDI
rules for energy, single-brand retail and defence.
Gold imports could fall 11% to 750 tonnes during the current
fiscal year after the government raised import duties to a
record 10% in the wake of the record current account deficit
last year, fed by Indians voracious appetite for the
precious metal. For those who turned to gold to hedge against
the falling rupee and rising inflation, Rajan has introduced
government savings bonds linked to the CPI, to be available at
the end of November.
Some foreign companies have pared back their investments in
the face of red tape and frustration, including Berkshire
Hathaway, Posco, ArcelorMittal and Wal-Mart, which had been
poised to capitalize on the opening up of multi-brand retail to
foreign investment before the reform was watered down. But
overall, international equity investors have not fled in great
numbers instead, theyve pumped more than $2
billion into Indian markets so far this fiscal year.
Finance minister Palaniappan Chidambaram continues to
maintain that the government is committed to enacting major
reforms and will not be cowed by the prospect of elections in
which their victory is far from assured. He has said that the
government plans to pass the long-awaited goods and service tax
in the winter session of parliament, and has backed the
fast-tracking of industrial approvals. Chidambaram has said the
government is sticking to plans to cut the current account
deficit to 3.7% of GDP during the fiscal year ending in March,
from the previous fiscal years record 4.8%.
But Chidambaram is himself a potential prime ministerial
candidate for the Congress Party, which recently pushed through
a $22 billion annual food security bill that will increase the
number of Indians entitled to subsidized food to roughly 800
million, more than half the countrys population.
No commensurate revenue increase has so far been
forthcoming, meaning the costs are likely simply to be added to
the deficit. India has a very limited revenue base, and
this is a commitment that takes it from 0.8% of GDP to
1.2%...[which] is a lot to add to your deficit, according
to Sheth, of Moodys.
Indias vast poverty means that a strong welfare state
is essential. But the RBI has long advocated for the reform of
a subsidy system in which over half of the food set aside for
the poor never makes it to its intended recipients. Critics
have also accused the government of populist pandering with a
land acquisition bill, which business lobby groups have said
will make it more expensive and difficult to acquire
agricultural land for development.
A possible credit rating downgrade now looms, with Standard
& Poors reportedly giving India a more than
one-in-three chance of being downgraded to junk status. That
threat may be just the threat the government needs, says
Shubhada Rao, chief economist at Yes Bank.
Realizing the perils of persistent economic slowdown
and the spectre of a sovereign rating downgrade, the
governments policy machinery has been extremely active in
the last one year, she says. This has started to
have a gradual positive incremental impact on domestic macros.
However, to sustain the positive tempo, it would be imperative
for the new government to persist on the path of administrative
and policy reforms.