The Rajan Effect

Raghuram Rajan Takes Charge As Governor of The Reserve Bank of India
(Source: JapanTimes)


It’s time to bid a bittersweet adieu to Rajan. On the 4th of September, Raghuram Rajan, the current RBI Governor, will have completed three years in office. In these years, Rajan has garnered immense popularity as a central banker, especially for his determination and strict policies of fighting inflation. He gained nicknames such as ‘R3’ and ‘Rockstar’ as a part of his massive fan-following. The media made a highlighted his every public move, even comparing him with the likes of James Bond, for his famous words “My name is Rajan. I do what I do.” All in all, Rajan was a new kind of Central Banker to India that his predecessors never were – the famous kind.

A IIT-D and an IIM-A Gold Medalist, Rajan is also a distinguished University of Chicago scholar. Before his stint at the RBI, he served as the Chief Economist of the International Monetary Fund. Rajan is best known for anticipating the 2008 subprime lending crisis in his paper, “Has Financial Development Made The Word Riskier?” He also reiterated his views in the post-crisis short film “Inside Job“.



His record at the Reserve Bank of India speaks for itself. Raghuram Rajan walked into Mint Street in September 2013 while a currency crisis was unfolding. The rupee was nose diving and had almost hit Rs. 69 to a dollar while currency reserves had hit a three-year low. Inflation was galloping as well and at that time looked far beyond anyone’s control. While Consumer Price Inflation had hit 9.84 per cent in September 2013, inflation in primary food articles had crossed the 18 per cent mark.

On day one as central bank chief, Rajan vowed to preserve the value of the currency. He waged a war against inflation and straightened the rupee in weeks. To calm the vulnerable rupee, Rajan launched the FCNR (B) (Foreign Currency Non Resident (Bank) account is an account that can be opened with an Indian bank by a Non Resident Indian or a Person of Indian Origin in foreign currency) scheme under which it offered discounted currency swaps to banks to spur inflow.

 Banks raised $25 billion through FCNR deposits and another $9 billion through foreign currency borrowings. Surprising many, Rajan hiked Repo Rate not once but twice in October 2013 and January 2014 to break the spiral of rising inflation. The Indian economy has seen significant changes over the three years that Raghuram Rajan has been the Governor of the Reserve Bank of India.

In September 2013, when Rajan took over, the economy was part of the infamous ‘Fragile Five’ grouping. Today, it is celebrated as the fastest growing major economy in the world.While fortuitous factors like a drop in commodity prices have helped steady the fundamentals of the Indian economy, so have sound macroeconomic policies like a focus on bringing down inflation, building foreign exchange reserves and allowing a steady increase in foreign participation in the Indian debt markets.


Here is a summary of how economic indicators have evolved during Raghuram Rajan’s tenure as the Reserve Bank of India Governor:


  • Rupee: To say that the rupee was in bad shape will be an understatement. Two months before Rajan took office, the domestic currency had depreciated by a staggering 10.4 per cent as India faced its worst currency crisis in recent memory. Ever since Rajan took over, the rupee has gained 1.12 per cent with implied volatility hitting an eight-year low last week


  • Lending rate: Lending rate, or the rate of interest banks charge from borrowers, stood at 10.3 in September of 2013. As of August 2016, it’s down by 90 bps at 9.3 per cent. High lending rate has been one of the key concerns in the second half of Rajan’s tenure, as repeated cuts in repo rate by the central bank didn’t get transmitted fully.


  • Inflation: Rajan is known for his primary focus on curbing inflation. His biggest achievement is that he successfully brought down retail inflation to 3.78% in July 2015 from 9.8% in September 2013 – the lowest since the 1990s. Wholesale inflation was down to a historic low of -4.05% in July 2015 from 6.1% in September 2013. Under Rajan, the RBI adopted consumer price index (CPI) as the key indicator of inflation, which is the global norm, despite the government recommending otherwise.


  • Equity: In his first speech as RBI governor, Rajan promised banking reforms and eased curbs on foreign banking, following which Sensex rose by 333 points or 1.83%. After his first day at office, the rupee rose 2.1% against the dollar. The equity market, although not directly under Rajan’s influence, has nonetheless had a blast during Rajan’s tenure. The BSE Sensex rose 51 per cent even since Rajan took office through August 8, 2016. The NSE Nifty50 has gained 60 per cent in the same period.


  • Gross NPAs:The biggest achievement of Rajan’s tenure may not look like an achievement at all. Gross non-performing assets at India’s scheduled commercial banks jumped three-fold from Rs 2,52,275 crore in December 2013 to Rs 5,94,929 crore by March, 2016, thanks to a clean-up of the banking system that has brought forth the ugly side of the banking sector. With a former RBI governor accepting the responsibility for not doing much about the issue, the burden fell on Rajan and his team.


  • Foreign Exchange : Perhaps, a hands-down winner during Rajan’s tenure, foreign exchange reserves of RBI have swelled to record high. From $275 billion in September of 2013, it now stands at a record $365 billion and will provide the arsenal to the central bank to brace for the FCNR bond redemptions coming up in September, which is likely to create some ripples in the currency market. India’s forex reserve is now stronger by about 30% than it was two years back.


  • Banking: Under Rajan, two universal banks have been licensed and eleven payment banks have been given the nod. This is expected to extend banking services to the nearly two-thirds of the population who are still deprived of banking facilities.


  • Interest rates:After initially raising nominal interest rates by 50 basis points, or 0.50 per cent, to quell inflation, RBI embarked on a journey of rate cutting which is now in its 18th month. When Rajan took office, repo rate stood at 7.5 per cent, which then rose to 8 per cent in January 2014. Post-January 2015, repo rate has been slashed by 1.5 per cent to 6.5 per cent, which is the lowest level in four-and-a-half years.


  • Current account deficit:The current account deficit, though essentially a finance ministry domain, has seen a marked improvement over the past three years, climbing down from a record high level of 4.10 per cent to 0.1 per cent in June 2016.


(Source: ETMarkets)


 Rajan’s early focus and battle with inflation earned him nicknames ranging from ‘Inflation warrior’ to ‘Inflation Hawk‘. There are a number of points to consider here when viewing the criticisms against Rajan’s stance on inflation and interest rates. He has more aggressively expanded on his predecessor’s attempt at using interest rates to curb inflation. The arguments in favour of Rajan having erred, when it comes to interest rates and inflation, are three-fold.

First, the central idea that the high inflation in the Indian economy was due to excess domestic demand is flawed. This inflation can be more attributed to global excess demand and thus raising interest rates was flawed. If this is true, Rajan’s restrictive monetary policy has been completely off the mark.

Second, even if Rajan’s initial stance of keeping inflation as the RBI’s number one goal was correct, he may have been too late in recognizing when this goal was achieved and therefore late in eventually cutting interest rates. Rajan at the time was still hesitant to cut interest rates even though retail inflation had fallen to 3.8%.

The problem of different perspectives here – whether India was undergoing disinflation or deflation – stemmed from the RBI’s decision to look at retail inflation (CPI) while deciding its monetary policy. So while the wholesale price index sat at negative 4% at that point of time, CPI was still at 3.8%.

The last argument for Rajan having tripped up was that even after he started his rate cut cycle, he didn’t do enough to help the money markets that were gasping for liquidity; a crucial side-effect of this was that a free transmission of rate cuts did not happen. It was only in his last year, and more specifically in the last five months, that the RBI governor set out to make more cash available in the banking system.

Out of these three arguments, there is greater evidence and support for the last two. In some ways it’s a pity that criticism levied against Rajan comes from parties that had a vested interest in his policies: politicians, India Inc. lobby groups, debt-laden promoters and wilful defaulters.

In his farewell letter, Rajan expresses a tinge of disappointment that he will not be able to see through two important developments: The formation of a monetary policy committee that may eventually reduce the role of the RBI governor, The asset quality review of public-sector banks.

Apart from these two issues, however, what has received less media attention was Rajan’s aim of overhauling the RBI’s administrative structure, including hiring talented external employees as well as improving the quality of institutional research.

One big mistake Rajan did was he failed to fathom the tolerance level of ruling political dispensation to criticism, especially on political matters. In a country, where all government bureaucrats are supposed to toe the line of their employer, no government servant, even if he is the RBI Governor, is supposed to speak his mind on sensitive political issues. That’s a taboo. The moment Rajan stepped out of his mandate and started commenting on political issues, the discord between him and the government started.

Rajan’s work is nothing short of exceptional. However, newer Central Bankers will most likely match his performance and maybe even exceed it. But whether India will have such an honest, outspoken and fearless Central Banker is a huge question mark. Rajan himself has assured that he remains loyal to India and will be happy to serve the people whenever he is called upon again. At this moment, we can only be thankful for his contributions and restate the message of the RBI Staff in their tribute rangoli to their outgoing boss: “Alvida na kehna” (“Never Say Goodbye“).


This article was written by Varnita Deep (PGDM, Batch 22,  XIME-B)



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