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Rajan Brings Stature to RBI Hamstrung by India’s Deficits

Raghuram Rajan, governor of the Reserve Bank of India (RBI), speaks during a news conference at the central bank's headquarters in Mumbai on Sept. 4, 2013. Photographer: Dhiraj Singh/Bloomberg
Raghuram Rajan, governor of the Reserve Bank of India (RBI), speaks during a news conference at the central bank's headquarters in Mumbai on Sept. 4, 2013. Photographer: Dhiraj Singh/Bloomberg

Sept. 5 (Bloomberg) -- India’s newly installed central bank Governor Raghuram Rajan burnished his international credentials at a 2005 U.S. conference warning about the danger of a potential crisis. Now he has one of his own to contend with.

Rajan, 50, joined the front lines of a battle to forestall a record slump in the rupee yesterday with a package of measures that may lure $10 billion in foreign-exchange inflows over three months, according to Barclays Plc estimates. The currency and stocks rose. Beyond the rupee, Rajan is also tasked with reversing dwindling growth and reining in inflation hammering 826 million citizens who live on less than $2 a day.

With mandates ranging from price stability to ensuring credit flows, the ex-International Monetary Fund chief economist inherits multiple goals with limited power to achieve them. A narrower focus on inflation, along with government action to shrink a fiscal deficit and boost infrastructure, would help as emerging-market turbulence exposes India’s fragilities, according to Rajan’s former IMF colleague Eswar Prasad.

“The main problem right now is that monetary policy is being forced to undertake an almost impossible balancing act,” said Prasad, who teaches economics at Cornell University in New York. “A narrower set of mandates could improve the RBI’s effectiveness.”

Rajan said yesterday in his first press briefing that achieving monetary stability is the Reserve Bank of India’s primary role and “this means low and stable expectations of inflation, whether that inflation stems from domestic sources or from changes in the value of the currency, from supply constraints or demand pressures.”

Policy Review

The comments reflected views that Rajan and Prasad laid out in a 2009 report that recommended India grant the central bank operational independence and limit its goals, with a focus on an inflation target. He said yesterday that a panel will report in three months on how to “revise and strengthen” India’s monetary policy framework.

Without statutory protections for now, Rajan will need to manage ties with his former boss, Finance Minister Palaniappan Chidambaram, who criticized the RBI last year for tardiness in cutting interest rates -- even as inflation remained above its tolerance zone.

The RBI chief, who began his three-year term after serving as the Finance Ministry’s top economic adviser since August 2012, has said India will do whatever it takes to stabilize the rupee.

Swap Window

Rajan said yesterday the central bank will open a swap window to help attract foreign-currency non-resident dollar funds. The central bank allowed commercial lenders to borrow an additional 50 percent of their core capital and swap that with the central bank at 100 basis points lower than the ongoing swap rate prevailing in the market, it said in a release. The monetary authority will also push for more trade settlements in rupee, it said.

The currency rose 1.5 percent to 66.09 per dollar as of 11:20 a.m. in Mumbai today after the announcements, paring losses over the past six months to 17 percent, still among the steepest drops in the world, according to data compiled by Bloomberg. The S&P BSE Sensex index advanced 2.2 percent. The yield on the 7.16 percent government bond due May 2023 slid to 8.23 percent from 8.39 percent on Sept. 4.

Credit-default swaps insuring the bonds of State Bank of India, considered a proxy for the sovereign, have climbed to 360 basis points, compared with 275 at the end of June, according to data provider CMA.

Foreign Inflows

“As these fresh RBI measures are likely to raise the possibility of better foreign-exchange inflows in the next three months, we see potential for a near-term improvement in market sentiment and the rupee’s trajectory,” Barclays said in a note today. “Such improvements might provide an opportune moment for the RBI to start unwinding its liquidity-tightening measures, possibly in September-October, albeit gradually.”

India needs to reduce the requirement for lenders to invest in government securities in a “calibrated way” to what is needed from a prudential perspective, Rajan said. He also said well-run commercial lenders will be allowed to open branches without the central bank’s permission.

Budget Deficit

Beyond the immediate market boost, India still faces risks from greater uncertainty in global financial markets as the prospect of reduced U.S. monetary stimulus spurs outflows from emerging markets, the threat of higher oil prices, and the government’s struggle to contain its budget deficit, according to Barclays.

A deeper reliance on foreign capital and bigger borrowing needs have seen India suffer more than most of its peers from the volatility sparked by concern that the U.S. Federal Reserve will pare back its stimulus. India’s current-account deficit estimated by the IMF at 4.9 percent of gross domestic product this year compares with a surplus of 1 percent for emerging and developing economies as a group.

The government’s deficit will amount to 8.3 percent of GDP this year, leaving a gross debt load of 66 percent, according to the Washington-based IMF where Rajan served from 2003 to 2006. Developing and emerging markets as a group have a budget gap of 1.8 percent, with a 34 percent debt burden relative to GDP.

“It’s completely shocking to see the way the economy is run in India -- there is no control over expenditure,” said Meghnad Desai, an emeritus professor at the London School of Economics who began teaching there in 1965. “A lot of things have gone wrong with India but the basic thing is the efficiency in decision-making has gone wrong.”

Crisis Oracle

Rajan grabbed global attention in 2005 highlighting flaws in decision-making of global regulators who pared back rules limiting competition in the finance industry. Deregulation contributed to a shift in manager incentives that increased risk, Rajan wrote in a paper for that year’s gathering of economists at Jackson Hole, Wyoming.

He concluded that “we should be prepared for the low probability but highly costly downturn” -- years before the world fell into its worst postwar recession.

“There is absolutely no doubt about Rajan’s credentials given his knowledge and global experience,” said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai. “But as long as there is a fiscally irresponsible government, monetary policy really can’t do much. The government has to set its house in order. Without it, no matter if it’s Rajan or anyone else, things won’t change.”

Singh’s Struggle

Chidambaram and Prime Minister Manmohan Singh, who rescued India from a balance-of-payments crisis working at the Finance Ministry in the early 1990s, are struggling to contain the current turmoil. While they have taken steps to usher greater investment from foreign companies such as Wal-Mart Stores Inc. and Etihad Airways PJSC, recent legislation stirred concern about their focus.

The government’s most recent legislative initiatives include a measure designed to boost food provision for the country’s poor, and a revamp of laws on land acquisition that improves compensation for owners.

The land bill “will slow the industrialization process,” and raise costs, while the food-security guarantee “may widen the fiscal deficit, raising inflationary pressures,” according to Standard Chartered Plc economists Anubhuti Sahay and Samiran Chakraborty in an Aug. 30 note.

Political Pressure

With an election due by May, Rajan may face pressure to lower borrowing costs and stoke growth. Chidambaram last October said it would be “good” for the RBI, then led by Duvvuri Subbarao, to bring down interest rates.

“A key factor here is whether the individual will typically buckle under government pressure or stand up to do the right thing,” said Rajeev Malik, an economist at CLSA Asia-Pacific Markets in Singapore. “This will be the ultimate test for Rajan.”

His first task is shoring up a rupee that RBI adviser Arvind Virmani said this week is in danger of sinking past 70 per dollar. He also needs to buttress the central bank’s credibility, which according to Virmani was hurt by premature intervention in the foreign-exchange market --before the exchange rate had overshot its fair value.

Raising borrowing costs to help the rupee would risk hampering GDP growth that weakened to 4.4 percent in the second quarter. Other options include steps to increase India’s foreign-exchange reserves.

Dwindling Reserves

The reserves have dropped about 13 percent to $278 billion since a 2011 peak and are equivalent to less than seven months of imports. Bank of America Merrill Lynch estimates India needs as much as 10 months of import cover for currency stability.

A stabilized exchange rate would help alleviate price pressures in a nation where gains in the benchmark wholesale inflation gauge averaged 6.5 percent in the past year.

There should be a move toward “the maintenance of low and stable inflation” as the RBI’s primary objective, a government-appointed panel led by Rajan said in the 2009 report. Rajan said in 2011 that central banks should add financial stability to the traditional goal of low inflation. Yesterday, he said that inclusive growth and development, and financial stability, are important mandates too.

“If we succeed in keeping inflation lower for longer as a result of inflation targeting, it will pave the way for strong economic growth and boost confidence,” said Dhawal Dalal, the Mumbai-based head of fixed income at DSP BlackRock Investment Managers Pvt., a unit of the world’s largest asset manager.

For now, with capital flight pushing up bond yields, low inflation alone is insufficient, according to Dalal, who has reduced holdings of long-term Indian government debt in favor of cash in his portfolio.

“It’s the government which has to deliver on cutting down on deficits, improve governance and the infrastructure -- absent that, no one can make any difference,” said Brinda Jagirdar, an independent economist who helped the Committee on Financial Sector Reforms produce the 2009 proposals Rajan backed.

To contact the reporter on this story: Kartik Goyal in New Delhi at

To contact the editor responsible for this story: Stephanie Phang at

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