Raghuram Rajan as RBI chief may have some surprises up his sleeve

Dr Raghuram Rajan, a former IMF economist, visiting professor to the World Bank and US Federal Reserve Board and one of the few economists who predicted the 2008 credit crisis will head the Reserve Bank of India. He takes over from Dr D Subbarao on the 4th of September.

What can one expect from the new RBI governor. He takes over the reins of the central bank at a time when the economy is going downhill, the Indian Rupee (INR) is on a free fall, equity and bond markets are nervous and the government at the centre wants quick fixes before the 2014 general elections.

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Dr D Subbarao came into office in the middle of the 2008 financial market crisis. He is one governor who in his term cut rates drastically and raised rates at the same pace. The repo rate under his term fell to levels of 4.75% from 9% and rose to levels of 8.5% from 4.75%. All in a period of five years. Needless to say the economy, markets and the currency has been on a roller coaster ride over the last five years due to various reasons both domestic and global.

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Rajan comes to the RBI governor post with a lot of expectations thrust on him by both the government and the markets. The government will want him to wave a magic wand to bring down deficits, strengthen INR and help the economy grow. The markets will want from him a calm, well thought out approach to handling both the economy and the government. A tough task by any means, as will be vouched by both Dr YV Reddy and Dr Subbarao, the former RBI governors.

The immediate focus of the RBI is to curb INR volatility and Rajan has been involved in this process since the time he came into the post of the Chief Economic Advisor to the Indian government in August 2012. The government and the RBI has not succeeded in curbing the volatility in the INR that touched all time lows of Rs 61.80 to the USD on the 6th of August, which is also the day of Rajan’s appointment to the RBI governor post. Rajan will be hard pressed to stem the INR fall unless luck in the form of global markets behaving well comes in his way.

Rajan’s past record shows that he can equate economics to markets and this is extremely important for a central bank governor. Whether one likes it or not markets determine the fate of economies as seen by the way indebted Eurozone economies are suffering due to austerity. India too is seeing the effect of the markets view on the INR as growth is suffering due to policies that are aimed to reducing INR volatility.

Rajan will focus on a longer term approach to the economy and market stability. He did predict the 2008 bubble burst, but he first predicted it in 2005. Similarly if he can focus on long term goals of the central bank that is price stability, growth and curbing systemic imbalances in the markets, he can bring about a change in the country’s prospects.

The government may not have the patience for long term goals of RBI. Rajan should stand off short term political pressures for longer term goals.

Rajan’s policies will be conservative, as he will not want to create market bubbles. His policies will also surprise to create a shock effect that shakes out excesses in the market. Markets can expect direction from the RBI going forward but that will not be cast in stone.

Here’s wishing him all the best in troubled time.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.