As India goes to the polls, its banking chief could pay price of prescience

As India goes to the polls, its banking chief could pay price of prescience

His views were once dismissed as Luddite, but Raghuram Rajan is key to rebuilding Indian economic confidence, writes Jeremy Warner

The son of an Indian bureaucrat who was brought up in Delhi, Prof Rajan shot to fame for his prescience on the financial crisis Photo: Bloomberg

By Jeremy Warner

4:19PM BST 13 Apr 2014

All central bank governors have their challenges, but perhaps none more so than Raghuram Rajan, head of the Reserve Bank of India, presiding as he does over an economy of 1.3bn souls – many of them living below the international poverty line – a near double-digit inflation rate, and a currency which until very recently was in abject free fall.

For much of the past week, he’s been at the spring meeting of the International Monetary Fund in Washington, where he has again criticised the US Federal Reserve for the turmoil its low interest rate policies has unleashed in emerging market economies.

As the IMF’s chief economist from 2003 to 2006, it is an environment he knows well. But it is perhaps developments closer to home that he needs to be most wary of as India prepares for an historic change of government.

Several senior members of Narendra Modi’s Bharatiya Janata Party have already indicated they want Prof Rajan removed should they be voted in, as seems likely, as punishment for his apparent closeness to the present government and the series of emergency interest rate rises he’s engineered to prop up the currency and get a grip on inflation.

It is to be hoped that wiser counsel prevails, for Prof Rajan, only very recently parachuted into the job, is key to rebuilding international confidence in India’s beleaguered economy. To fire him would be to guarantee fresh turmoil in the markets just as he has succeeded in calming things down. There would be no more effective a way of the new government shooting itself in the foot. Indeed, if Mr Modi is serious about reinvigorating India’s economy, one of the first things he should do on becoming prime minister is to grant the Reserve Bank of India full independence, with a clear mandate to support growth by targeting a tolerable and stable inflation rate.

That at present it has neither of these things, and indeed that political leaders can so freely threaten to sack the Governor for doing the job as he sees fit, is a key institutional failings at the heart of the Indian economy. A truly modernising Indian government would move swiftly to correct this flaw.

When I catch up with Prof Rajan in an airless room somewhere deep in the maze-like corridors of the IMF ’s Washington headquarters, he’s suitably diplomatic in addressing these questions.

“It may seem a little philosophical,” he says, “but I do not know what we mean by independence. All central bankers have various political pressures fed back to them, whether independent or not. I believe I already have a fair amount of independence. What an institutional framework does is improve the perception of independence, but I think I have sufficient freedom of action to do what I need to do.”

In any case, he believes there is no immediate need for a mandate to bring down inflation. Time should be allowed for the debate to play out, he says, and a consensus on the way forward to be reached. “I don’t think 2pc would be the right target for India. Numerous Indian committees have suggested 4pc. You want to start with a higher mandate because we have a higher rate of inflation and we don’t have the same issues as industrial countries.”

The son of an Indian bureaucrat who was brought up in Delhi, Prof Rajan shot to fame for his prescience on the financial crisis. In a paper to a 2005 symposium honouring Alan Greenspan, the former Fed chairman, Prof Rajan warned about the way bonus-driven financial innovation was increasing risks in the banking system. His remarks were dismissed as “Luddite” by former US Treasury Secretary Larry Summers, but two years later were proved to be spot on.

While at the IMF, Prof Rajan also delivered a series of warnings about the build-up of imbalances in the world economy, and in particular the accumulation by Asian countries of massive foreign exchange reserves, which meant that some of the poorest countries in the world were in effect lending some of the richest the money to buy their exported goods.

Despite the financial crisis, Prof Rajan says, few of these structural fault lines have yet been resolved. Indeed, they may have been made worse by the “unconventional” monetary policies such as quantitative easing put in place to counter the financial crisis.

“I was a fan of QE1, which was pursued to fix the mortgage market,” he says, “but continuing it beyond a certain point to try to revive growth in an environment where you have a big debt overhang, and you have people who cannot expand consumption, and firms so worried about political uncertainty that they will not invest, has not been positive and is producing undesirable spillover effects. “If some countries are pursuing easy monetary policy, you have to match them or you get a deflationary effect in your own country and that results in a race to the bottom.

“You have to worry that economies have become too dependent on monetary policy. Where is the fiscal discipline? Where is the structural reform? Once you say these things aren’t politically feasible, the question becomes whether monetary activism is actually preventing pursuit of these other solutions.”

The key to understanding the crisis, according to Prof Rajan, is that it is not at root cyclical, but a response to a variety of structural problems. “Unless we move away from the interpretation that a cyclical response is the right one, we will keep on with half-measures. The belief that if you cut interest rates a little bit more or further tweak asset prices, we’ll soon see growth return, ignores the true solutions, which lie elsewhere.”

So what of India, where the structural obstacles to growth and advancement can sometimes seem so extreme as to be insurmountable? “Yes, I wouldn’t say India is at the top of the class,” he grins. “We need to improve the supply side considerably. There is movement. For instance, landing at a major city in India today, you will come into a modern, newly- built airport. But there are massive infrastructure improvements still to be made to bring down the costs of doing business in India.”

Much of the supply-side revolution India needs – particularly when it comes to still endemic levels of corruption – is not in Prof Rajan’s gift, but there is plenty he can and is doing to improve the quality and supply of finance, a key enabler of long-term growth.

“We are working in multiple dimensions strengthening markets, strengthening institutions, improving the quality of competition. For instance we have just licensed a couple of new banks in the most transparent way possible, a not insignificant achievement in an environment where everyone is talking about corruption.”

Innovative use of technology could allow India to leapfrog western financial models, Prof Rajan hopes, in reaching remote villages and catering for the massed ranks of India’s great unbanked.

He also has high hopes for a new exchange that will allow SMEs to trade their bills. “We have set the structure for an exchange, and have some people who have volunteered to set up that exchange. Now let a thousand flowers bloom and see what happens.

“If we get finance improved, improve the depth of markets, we as a central bank don’t need to venture out into broader supply side issues. By doing these things we put pressure on the real economy to improve its performance… Things are coming together, including a new bankruptcy law, that will improve the quality, transparency and liquidity of markets.”

India has always been a lesson in promise unfulfilled. Once again, there are high hopes for its prospects with the likely, though not yet certain, ascent of Mr Modi, a man with a reputation for getting things done. But he won’t succeed without the financial stability that only an effective central bank can deliver. Here are two men who could transform the world’s most populist nation. Time is running out. India cannot afford another disappointment.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: