Central bank governor of the year 2014: Rajan emerges unscathed from Indian baptism of fire


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Reserve Bank of India governor Raghuram Rajan’s tough monetary medicine combatted the storm ravaging the deficit-ridden economy in the recent emerging market crisis. Now, he is battling vested interests to arouse a sleepy financial system for over one billion people.


The most effective modern central bankers deploy an old-fashioned virtue in the teeth of market distress: stoic calm. Few, however, have articulated this ethic with as much clarity and charm during a trial by fire as Indian central bank governor Raghuram Rajan. As Fed-tapering fears triggered investors to punish India for its fiscal and current-account deficits last year, Rajan, during his maiden speech on September 4, cited excerpts from Rudyard Kipling’s classic poem ‘If’ as a paean to the steely resolve of a central banker.

As he confronted capital outflows, the rupee at record lows, and over-blown, but palpable, fears India was marching towards an Asia-crisis-style abyss, Rajan duly administered tough monetary medicine to ailing bond and currency markets.

Remarkably, the internationally-renowned economist, who earned acclaim for his warnings in 2005 of an upcoming global crisis of sorts, has, for the past year, been true to his word while charting India’s exit from the group of ‘fragile five’ emerging market economies.

The former Chicago economist immediately boosted market transparency by clarifying the RBI’s policy direction in favour of inflation-targeting, while opening a swap window for deposits from nonresident Indians and allowing banks to borrow more overseas, all in a bid to court badly-needed capital.

Investors credit the governor for bringing a steely focus and stability to the RBI’s policy framework by embracing the CPI inflation trajectory, gunning for an accountable goal of sub-8% by January 2015, and sharpening monetary operations by focusing on the repo rate as the benchmark tool.

These measures, combined with an emergency fiscal package at the tail end of the former left-leaning administration’s tenure as well as an uptick in global sentiment, have drawn a dramatic close to India’s financial crisis. In addition, his fire-fighting efforts, through quantitative measures and aggressive repo rate hikes, have bought the new Narenda Modi-led administration much-needed time to address fiscal and supply-side woes.

Abhijit Sen, chief financial officer for Citibank India, sums up faith invested in the governor by the country’s banking establishment: “The RBI, under Rajan, did an outstanding job protecting the economy from the global contagion [last year]. It is now bringing stronger supervision to the banking industry, by monitoring large-scale exposures and foreign currency liabilities.”

The RBI has been traditionally conflicted given its full-service mandate: inflation fighter, growth driver, as well as financial watchdog, and government debt manager.

Rajan is now shifting the RBI away from its dual growth-inflation mandate by focusing on the latter, which, in the medium-term, promises to boost financial savings, generate risk capital, and increase consumers’ purchasing power – but at a short-run economic cost.

In sum, from sharpening the instruments, objectives and the internal workings of emerging Asia’s second-most powerful central bank, Rajan has lived up to his promise. As fears snowballed the governor’s hawkish posture would clash with a growth-orientated administration, he has asserted the independence and transparency of the institution in the grip of market distress.

Perhaps more significantly, Rajan, a former IMF chief economist, knows only too well India’s diverse, and increasingly complex market-orientated real economy needs a stronger and more liberalized financial sector. Rajan now has the leverage to implement his manifesto for a new liberalized financial order, first penned in 2008, at the RBI. In the teeth of vested interests, a slow bureaucracy and crony capitalists, Rajan wants to retool the banking system to bring an end to large-scale financial repression – as the government chokes banks with an over-supply of paper – while introducing investment into more productive sectors, lowering the cost of long-term capital through competition, and bringing the underbanked into the formal sector.

K. Vaman Kamath, chairman of ICICI, India’s biggest private-sector bank, and a grandee of Indian finance, adds: “His biggest challenge was to get the rupee under control. Once he did this it broke the back of the speculators. He displayed confidence and demonstrated how he brings to the table a wide variety of skill sets, as an economist with international experience. He is also moving the RBI away from institutional conservatism, when it comes to financial regulation, but we will have to give him time to deliver.”

While the global financial crisis and India’s recent roller coaster has underscored the systemic risks of financial liberalization, reform of public-sector lenders, which represent 70% of system assets, and a less state-directed banking system, more generally, has its best chance of succeeding under a reformist RBI.

There are many battles ahead. Incumbent industrialists will continue to siphon off credit and resources given the toxic nexus between power and capital. The tension between repairing the banking industry, after the 2009-2012 credit splurge saddled public sector banks with as much as 12% of bad loans, in the short-term, and liberalization in the medium-term, will vex the reform agenda. What’s more, the government will be tempted to defer reforms of ailing public-sector lenders, which represent 70% of sector assets, in favour of maintaining their role as a vehicle for fiscal policy.

Meanwhile, red tape, bureaucratic inertia, and the need to maintain banks’ role as a captive buyer of government bonds, given the size of the deficit, will temper the pace of reforms. But in Rajan – an outsider to the political system but whose international stature has provided him with the credibility to tout the virtues of reform – India has its best chance to become a capitalist heavyweight since the dismantling of the ‘Licence Raj’ regime in the 1990s, backed by a pragmatic, growth-orientated Modi administration with a strong mandate, say top Indian bankers.

Axis Bank CEO Shikha Sharma says: “We are very lucky to have Governor Rajan. He is modern and brings knowledge, expertise, and a modern outlook, though grounded in reality, to an institution that has been traditionally conservative.”

India has traditionally punched below its weight in international financial diplomacy given the relatively closed nature of its banking system and debt market, as well as its reliance on domestic consumption and savings to power growth. However, Rajan has asserted a more muscular posture at the RBI by calling on the Fed to be mindful of the negative spillover effects of its monetary cycle, and warning ultra-loose liquidity conditions in the West are sowing the seeds of another crisis.

While emerging market policymakers have thus far failed to provide concrete proposals to improve the international financial architecture, the former IMF official boasts credibility and powerful insights on global liquidity arrangements that will prove helpful in barricading India from capital storms.

Rajan has been a superb crisis manager and injected reformist energy to a conservative institution, but his mission to combat vested interests and retool the financial system to deliver India’s growth potential has only just begun. He needs a second term to deliver.