No magic wand: Raghuram Rajan, welcome to the RBI tightrope walk

Bimal Jalan, an astute policymaker and former Reserve Bank of India (RBI) governor, had a way of putting things. He used to say one of the key tasks for the RBI was to ‘manage expectations’. Raghuram Rajan, the 50-year-old star economist who takes over as the next RBI governor from Duvvuri Subbarao on 5 September, seems to be doing that already.

On the eve of his taking charge of the country’s monetary authority, Rajan made it clear that there was ’no magic wand’ and the challenges which were facing the economy were not going to be overcome overnight. One step at a time, making progress every day is the way Rajan, widely regarded as the man who correctly predicted the 2008 financial crisis, wants to do it.

And Rajan is probably right. He takes charge of the top job at Mint Road at a time when the RBI is caught in a cleft-stick on the growth-inflation dynamic, with growth slowing down to a modest 4.4 percent in the first quarter, and wholesale price inflation back to somewhat uncomfortable levels, touching 5.79 percent in July. More importantly, the rupee has been falling precipitously for some time now, and breached the 68 to the dollar mark once again during trades on 3 September. Both the currency and capital markets are in fresh turmoil over fears of war in Syria, while concerns over the exact timing and intensity of the US Federal Reserve’s tapering of its stimulus program continues to keep the markets and the currency on edge.

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[caption id=“attachment_1083283” align=“alignright” width=“380”]  It would not be fair to judge Raghuram Rajan on the basis of his first few decisions as RBI governor. Reuters[/caption]

At this juncture, perhaps the smartest thing the new RBI governor, a former IMF chief economist, can do is to carefully manage expectations and keep his eyes firmly on the immediate task at hand: calming the frayed nerves of market players and policymakers and making the best possible assessment of the situation under the circumstances. He can, however, do little about the burden of expectations he carries, particularly in view of his formidable reputation as an economist of international standing.

The growth-inflation dynamic, and the policy trilemma which Rajan’s predecessor Subbarao eloquently spoke about, will keep Rajan and his colleagues at Mint Road busy. With the current account deficit (CAD) and its impact on the currency posing a major threat to financial stability, Rajan will have to find ways to ensure the rupee stabilizes, while keeping in mind the pressing need to restart the growth engine as much as RBI, on its own part, possibly can. As Subbarao will testify, that task itself is a massive one, and can keep Rajan very busy.

In his last public address before demitting office, Subbarao made the RBI’s policy dilemma amply clear. “Yes, growth has moderated, but to attribute all of that moderation to tight monetary policy would be inaccurate, unfair, and importantly, misleading as a policy lesson. India’s economic activity slowed owing to a host of supply side constraints and governance issues, clearly beyond the purview of the Reserve Bank,” he said, underscoring RBI’s limited role in pushing growth in the absence of support from the government’s end.

“Indeed, low and steady inflation is a necessary precondition for sustained growth. Any growth sacrifice in the short term would be more than offset by sustained medium term growth. I want to reiterate once again that the Reserve Bank had run a tight monetary policy not because it does not care for growth, but because it does care for growth,” Subbarao said in the clearest possible manner.

Since that 29 August speech, very little has changed. In fact, the looming fear of war has made markets more jittery. This is likely to pose fresh challenges for RBI in its effort to keep the rupee stable.

Tackling North Block

Another brilliant former RBI governor, Yaga Venugopal Reddy was often known to say in his inimitable manner that just as the RBI could not be expected to agree with the government simply because it was the government’s view, equally, the central bank would not be right in not listening to a particular point of view merely because it was the government saying so. It is this delicate balance which Reddy and Subbarao after him had sought to strike at all times: when does one go along with the government’s view and when does RBI ensure it does what is best for the financial system, reinforcing its autonomy. There will be no clear answers to this for Rajan, but the choice will get tougher with the headwinds growing stronger. How Rajan tackles the pulls and pressures of North Block will be one of the key standards on which he will be judged.

By all accounts, Subbarao’s 5-year tenure was marked by heightened crises, first the Lehman crisis and then the Eurozone problem. Even as he demits office, another challenge - managing the impact of the Fed’s tapering plan - looms. Rajan takes over at an equally difficult time, with India’s growth story in serious jeopardy and the international community keenly watching how policymakers get it back on track.

It would not be fair to judge Raghuram Rajan on the basis of his first few decisions as RBI governor. But these are times when every action emanating from Mint Road will be discussed, debated and dissected threadbare. The first such occasion will come just days after Rajan takes over, with the 18 September review of the RBI Annual Policy. How Rajan takes his first steps as governor could go a long way in deciding how India will tackle what is quickly turning out to be the most challenging period the country has witnessed in a long time.