New Indian Central Banker Needs 'Shock and Awe Tactics'

Economic adviser Raghuram Rajan Photograph by Munshi Ahmed/Bloomberg

With the Indian currency hitting new lows and foreign investors pulling their money out of the country, India’s new central bank governor is in for a rough start. Raghuram Rajan, the government’s top economic adviser, will take over as head of the Reserve Bank of India (RBI) next month, Rajan’s boss, Finance Minister Palaniappan Chidambaram, announced yesterday. Rajan will step into the new role on Sept. 4, when current Governor Duvvuri Subbarao’s term ends.

Subbarao won’t be leaving on a high note. India is suffering through its slowest growth in a decade, while at the same time, inflation is high and the currency weak. The current-account deficit hit a record 4.8 percent of GDP in the fiscal year ended March, consumer price inflation is close to 10 percent, and the central bank last week lowered its economic growth target to 5.5 percent for 2013-14. That might sound healthy to readers in the U.S., but as a developing economy, India should be growing at a much higher rate.

Rajan’s appointment is a rare bit of good news. Subbarao and Chidambaram disagreed about monetary policy. A PhD from MIT who worked as chief economist at the IMF, Rajan last year took a leave of absence from his position at the University of Chicago to become the top economic adviser to Chidambaram. The two helped light a fire under India’s moribund economic reforms, providing some hope that the scandal-plagued government of Prime Minister Manmohan Singh could regain investor confidence.

That hasn’t happened yet. But with Chidambaram’s top adviser about to take over as India’s central banker, Indians can at least hope for greater cooperation between the country’s top economic policymakers. They need to stick together. The rupee has lost more than 11 percent of its value against the dollar in the past three months, making it the worst performer in Asia and the second-worst in emerging markets, after Brazil’s real.

For countries with a big base of exporters, a falling currency could be helpful, improving competitiveness. But India’s manufacturing sector is not nearly as developed as those in China or Southeast Asia, so the falling currency won’t give much of a boost to export growth—and the rupee’s slide makes financing India’s current-account deficit more difficult. “Rajan will face a baptism of fire as he confronts the mounting difficulties facing the Indian economy,” IHS chief Asia economist Rajiv Biswas wrote in a note published today. “However he does still have weapons in his toolkit, although he needs to deploy them rapidly to avert a deepening rupee crisis.”

Biswas argues Rajan should embrace “shock and awe tactics” to stabilize the currency. They include setting up a $30 billion swap line with the U.S. Fed to provide the RBI access to dollars in a liquidity crunch. The swap line would be identical to those established between the Fed and its counterparts in South Korea, Singapore, Mexico, and Brazil in 2008. India could also raise money from its expatriates, so-called nonresident Indians (NRIs), in a bond offering and encourage NRIs to deposit money in India by offering more attractive interest rates. NRI deposits in India were $70.8 billion in March, Biswas says, compared with $58.6 billion a year earlier.

The NRI numbers are one bit of good news. Most of the others, though, are heading in the wrong direction. Since the start of the budget year on April 1, the government’s expenditures have been 22.7 percent higher than during the same period a year earlier; the target was 16.4 percent. At the same time that the government is spending more than planned, it is taking in less: Revenue collection is up 1.4 percent, far short of the targeted increase of 23.4 percent. “The risk of slippage this year is significant,” Bloomberg economist Tamara Henderson wrote in a note published today.

Foreign investors withdrew $3 billion from stocks and bonds last month, adding to the challenge of funding India’s current-account deficit, which hit a record 4.8 percent of GDP in the year ended March 31. “Monetary policy in India has had to make a sharp detour,” according to Henderson, “from supporting the slowest growth in a decade with rate cuts to stabilizing the currency with a cash squeeze that will hurt growth and discourage investment.”

Rajan has made clear people shouldn’t expect too much too soon. “These are challenging times for the Indian economy, though no one can have any doubt about the country’s promise,” he said yesterday. “The government and the reserve bank are working together to address these challenges. We do not have a magic wand to make the problems disappear instantaneously, but I have absolutely no doubt we will deal with them.”

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