Lay off, Mr Subramanian Swamy! Raghuram Rajan isn't the villain here

When Subramanian Swamy, the maverick BJP politician whom the government nominated to the Rajya Sabha recently, makes you his enemy, you can bid goodbye to peace and tranquillity. The powerful and the corrupt cringe when Swamy decides to anoint them Public Enemy No 1, as the Congress found out earlier this month when he went hammer and tongs against Sonia Gandhi on the AgustaWestland bribery scandal.

Raghuram Rajan. Reuters

Raghuram Rajan. Reuters

However, it is difficult to fathom Swamy’s antipathy to Raghuram Rajan, the Reserve Bank Governor, who is one of the most respected central bankers in the world. So when Swamy writes to Narendra Modi asking the latter to “consider terminating the appointment" of Rajan when his term ends in September, one wonders which bee got into his bonnet this time.

The letter gives two reasons for Swamy’s opposition to Rajan getting a second term this September.

One, that Rajan is “mentally not fully Indian” since he continues to renew the Green Card issued by the US government. But this is bunkum; the Reserve Bank Governor’s post does not require any overt demonstration of patriotism or self-exclusion from future academic jobs in the US by tearing up the Green Card.

It is worth recalling that the Governor of the Bank of England, Mark Carney, is a Canadian. He too has been under political attack for warning Britons that a Brexit – British exit from the European Union – could spark a “technical recession.” A Tory MP has demanded his head for making such a “political” statement, but central bankers are not supposed to be shrinking lilies when it comes stating what they think is the truth.

Rajan too has not been too careful with his choice of words when expressing his views – the recent reference to one-eyed kings did not go down too well with the Modi government – but gagging central bankers is not the answer. They are paid to tell it like it is. Why shoot the messenger when you can anyway debate them or ignore their advice?

Two, Swamy’s other grouse seems to be Rajan’s focus on inflation, and his decision to keep interest rates relatively high to deal with the problem. Swamy thinks this has been “disastrous” for small businesses, which create most of the jobs.

This argument at least can be debated, for not all economists agree on whether inflation can be curbed by high interest rates alone. There is, after all, a fiscal dimension to inflationary pressure, and a supply management option. Raising interest rates will, for example, not bring down the inflation in pulses or potato or even cereals, for that matter.

All three are items of mass consumption that have contributed to the recent ballooning of food inflation. Cereal prices are impacted by overall monsoon behaviour and minimum support prices, and less by interest rates. The rain gods matter first, the cabinet’s decision on MSPs comes next, and interest rates matter the least.

On the other hand, Swamy can hardly claim that the focus on inflation is purely Rajan’s doing. Under an agreement reached between the finance ministry and the Reserve Bank last year, the central bank has to bring inflation down to 4 percent over the medium term and is accountable to the government for not achieving this objective over a timeframe.

The Reserve Bank has only two instruments in hand to attack inflation – interest rates, and liquidity measures. Both affect the cost of money for borrowers. Rajan is using both to do his job. If Swamy wants rates cut, all he has to do is write to Arun Jaitley to scrap the inflation agreement and the RBI could then be expected to let rates fall. Or the government could set a higher inflation target, and Rajan will surely be happy to cut rates faster. You can’t on the one hand hold the RBI responsible for inflation and then not give it the tools to do the job.

Another reason why Swamy is wrong to target Rajan is his belief that interest rates impact small businesses and hence jobs.

This linkage is tenuous. High rates surely impact business costs, but margins depend on both costs and revenues. When the topline is not growing for many corporates due to weak demand and a sluggish industrial economy, to expect lower rates alone to do the trick is a bit much. A cut in rates may improve short-term margins, but may do nothing to help small companies to sell more, start investing and create jobs.

For that, the overall outlook for growth has to improve. If demand is good, even higher rates will not matter, for margins start expanding anyway. To create jobs, we also need labour law reforms. So the rates-versus-growth argument cuts both ways; it is a chicken-or-egg kind of argument, and the causality runs both ways.

Another point Swamy could consider is this: if rates fall, savers get less. This will affect many more people than just small businesses. A premature cut in rates can also reduce the attraction of foreign inflows into Indian debt, which has its own consequences for the rupee. A rupee falling due to lower domestic rates (compared with what investors can earn in the US) can also impact inflation negatively as oil import costs soar, fuelling cost-push inflation.

Another angle of attack for Swamy has been Rajan’s shift from targeting consumer inflation to wholesale inflation. Swamy wrote: “When the Wholesale Price Index (WPI) started to decline due to induced recession in the small and medium industry, he shifted the target from WPI to the Consumer Price Index (CPI) which has not, however, declined because of retail prices. On the contrary it has risen. Had Dr Raghuram Rajan stuck to WPI, interest rates would have been much lower today and given huge relief to small and medium industries. Instead they are squeezed further and consequent increasing unemployment.”

It is certainly true that CPI and WPI have been on separate planets, but the problem here is not CPI, but WPI. The WPI has been in negative territory for 17 months and turned positive only this April. But the WPI is outdated, with a base year that is 12 years old. It does not represent changes in the economy over the last decade. The CPI has a base year closer to today. So Swamy is comparing apples with oranges when he says WPI would have been a better inflation gauge than CPI. What bites us is CPI inflation, not WPI.

Swamy is on the wrong track with Rajan. Rajan is probably the best thing that happened to the Indian economy in a long time. Targeting him for the wrong reasons does Swamy no credit. He should lay off.

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Updated Date: May 17, 2016 15:39:32 IST

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