The photograph could have been straight off a Hollywood billboard, a la George Clooney & Co in Ocean’s Eleven. Of course, this wasn’t a group heading for a heist but Team RBI with the new signatory of the currency, Governor Raghuram Rajan. Widely credited for predicting the 2008 crisis, this week Rajan took charge of the war to save the rupee and allied territories. Evidently, the halo had an effect. He came, he spoke and—it would seem—the markets concurred. The rupee recovered from the troughs at 68/dollar to 65.24/dollar.
It is not as if the fundamentals have changed. But perceptions seemed to, at least for now. Instant hagiologists have described the recovery of the rupee as the Rajan Effect. Students of science would know that the Raman Effect is about the ‘inelastic scattering of photons’ that today enables the analysis of materials. The Rajan Effect and the ‘Ifs’ of the Rupee Raga deserve material analysis.
India’s economic crisis has its genesis in the practice of politics. The Act demands that the RBI deliver monetary stability and instil confidence in the purchasing power of the currency. Both objectives have been laid vulnerable. Economics tells us that there is no such thing as a free lunch. India’s political class though preaches just the opposite—to garner votes through public funding of private political ambitions.
Rajan brings to the table the critical three Cs: Comprehension, Confidence and Clarity. Rajan comes with a reputation for Comprehension of the complexities of global finance. Unlike his predecessor, he has the Confidence of the Prime Minister and more importantly, the Finance Minister. He has also, clearly, prepared for the job while at North Block. His arrival statement had Clarity and a firm grasp of the obvious issues.
The flurry of initiatives conveyed a sense of urgency and that he was action-oriented. He also said the right things. Competition in banking, the promise to issue new bank licences sooner and not later, the dismantling of branch-by-branch permission-ism, the invitation to foreign banks to choose the subsidiary route, the idea of freeing banks from locking resources in government securities, the freer forward cover norms for exporters and importers were all what the market wanted to hear.
Not all of it was mint fresh. There are also embedded risks of resistance and of failure. Those who bag licences will—like the telecom players earlier—resist “on tap” further issue of licences as it will hurt valuations. Reduction in SLR requirements will be opposed on Raisina Hill and on Mint Street. The idea of deeper debt markets and need for long-term instruments have been ambitions since the 1990s but cannot take off sans better inclusion. Inclusion has been thwarted by obstructionists who have blocked technological avenues for free-form banking. The idea of interest rate future contracts for market discovery of price/yield is good but he must ask why the future contracts for 10-year and 91-day paper have failed. Similarly, should RBI be mandating inflation indexed instruments, when it is an obvious opportunity for banks and mutual funds?
The challenge for Rajan is not in managing the rupee which simply reflects consequences. The challenge is to limit the causative impact of the political derivatives market. His confidence and clarity will be tested. As the author-editor of the Economic Survey of 2013, he knows stalled investments have crippled growth. India’s fiscal and current account deficit worsened with higher import costs and fuel subsidies. His predecessor will tell him how in the winter of 2011 he was told that the government will address fuel pricing but did not as it was found personally and politically costly. He would know as the former CEA that even the Prime Minister cannot get recalcitrant ministers to propel investment in coal, iron ore and petro projects to curb imports. And without energy and investments, growth will only plummet.
There is also the global uncertainty —the possibility of war in Syria and its impact on oil prices. The autonomy of the RBI is mostly a concept. The reality is that as the government’s banker, it must fund it and as the evangelist of growth, it must face the reality that the weapons of mass alleviation—cutting subsidies, containing fiscal deficit and pushing investment—are all vested with the government. Regardless of the fundamentals and the potential of demography, the economy is judged on current, not plausible, growth. Any vitiation of the circumstances will serve as a trigger for rating agencies, the threat of junk rating will be a reality. The cause may be political but the consequence will be on his lap.
At the conclusion of his statement, Rajan quoted from Kipling’s If to breathe reality. The purple prose of India’s crisis is replete with innovative profligacy, indecision and incapacity. That is normal in India. This being an election year, perversity will rule and rationality will be rationed. In Kipling’s words, he will have to bear and watch truth being “twisted by knaves to make a trap for fools”.
In the coming weeks and months, the Rajan Effect will be repeatedly tested as Governor Rajan is measured against perception and compared with Raghuram Rajan.
shankkar.aiyar@gmail.com
Shankkar Aiyar is the author of Accidental India: A History of the Nation’s Passage through Crisis and Change