Raghuram Rajan's recent surprise rate cut was what central bankers call an "insurance move." In a highly uncertain and deflationary world, the Reserve Bank of India governor decided he'd rather risk higher inflation in hopes of boosting growth. More quietly, Rajan is taking out another policy that could pay even bigger dividends in years to come. He's hoarding dollars.
On Friday, the day before Barack Obama flew to New Delhi for his lovefest with Prime Minister Narendra Modi, the RBI announced that India's foreign-exchange reserves had risen to a record $322 billion. While the news couldn't compete with the Modi-Obama hug at the airport, a nuclear deal and talk of cooperation on climate change, that swelling stash greatly increases the odds that Modi's reform program will succeed.
Rajan's shock rate move on Jan. 15 was itself a boost to so-called Modinomics. By slashing the benchmark rate to 7.75 percent from 8 percent, the RBI governor made clear the central bank was ready to guard India's economy against a fast-mounting number of risks around globe. Equally important, says Marc Chandler of Brown Brothers Harriman, was the "vote of confidence" the decision signaled about Modi's government.
Now Rajan's stockpiling of currencies should help catalyze change in New Delhi. As recently as September 2013, when Rajan started at the RBI, India was spiraling toward crisis. An economy once celebrated as one of the superpowers of the future -- Brazil, Russia, India and China, or the BRICs -- was being grouped among the world's most "fragile" nations. Hedge funds bet India would be the first of the BRICs to be downgraded to junk.
Rajan moved fast to halt a run on the rupee, shore up the banking system and cap inflation. More recently, he's been building up India's defenses as emerging nations brace for Federal Reserve rate hikes and a new euro crisis. Nizam Idris, a Macquarie Group strategist, reckons that Rajan has stockpiled about $59 billion of reserves since taking charge at the RBI, or an average of $4 billion per month. While India's reserves are still a fraction of China's $3.8 trillion, they're substantial enough now to "create a stronger firewall against external account shocks and build greater international confidence," says Rajiv Biswas of IHS Global Insight.
India represents something of an outlier in the region. While Asian peers devalue to boost exports, Rajan has clearly decided that a stable, strong rupee is the key to cementing trust in India's economy, which still suffers from a sizable current-account deficit and relies on short-term capital flows. A firm currency should attract overseas capital to support equities, upgrade infrastructure and pay down government debt.
This offers an opening for Modi; the question is whether the prime minister will seize it. In July, the prime minister's first budget avoided "big bang" reforms like allowing foreigners to hold majority stakes in key sectors like insurance and defense. His government sidetracked a World Trade Organization deal to cut tariffs. And while he harnessed the plunge in oil prices to trim subsidies, Modi has been slow to dismantle budget-busting support programs.
Modi needs to get serious with his first full budget, expected in late February. He enters the process with a rare economic tailwind. By stabilizing the financial system and shoring ups its defenses, Rajan has given Modi considerably more latitude not only to restructure the economy, but to take risks like selling state assets and welcoming more foreign involvement in the economy. Once India reforms and moves beyond the boom-bust cycles of the past, it should be able to turn around and use its reserves to invest in education and healthcare as well as roads, bridges, ports and the power grid.
Dominic Bunning of HSBC says "an improving policy framework and the positive reform momentum we are seeing" make him increasingly bullish on India. He's not the only one. While China is growing faster -- 7.3 percent versus 5.3 percent -- India is widely expected to pull ahead in 2016. Both countries have seen stock gains in 2014 in the 40 percent or more range, even as markets in Brazil and Russia have sagged. "I might be tempted to call it just 'IC'," Jim O'Neill, the economist and Bloomberg View columnist who coined the term "BRICs," quipped recently.
All Rajan has done, though, is prepare the ground. The onus still lies on Modi to push forward the politically difficult reforms he's avoided thus far. He's now got 322 billion good reasons to do so.
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