If we accept that the markets are manic-depressive, we should discount the ecstatic welcome given to Raghuram Rajan on his taking over as Reserve Bank of India Governor last Wednesday (September 4).
If you ask yourself how many century-on-debut cricketers went on to become truly great cricketers, you will know what I mean. A century on debut always means public expectations are too high, and hence unlikely to be met in most cases. More critically, we all know how rapturously P Chidambaram's reforms of August 2012 were received by the market. We also know where the rupee stands, where growth is headed, and where inflation is stuck even after a year of so-called "reforms".
Raghuram Rajan can, of course, be an exception to the rule, but one has to understand the limitations of what a central banker can do when faced with a recalcitrant government - as Duvvuri Subbarao did.
The first thing to remember is that the RBI's impact on the economy is through its control of the banking system. It can impact the economy through interest rates, through the pre-emption of bank money, by controlling the rate of credit growth, and by prescribing tough conditions for bank functioning that can have the effect of pepping up or tapering down economic activity - in specific sectors, or through the economy. For example, by curbing how banks lend money for property purchases under the 80:20 scheme, it can curb credit to this sector. But it can't end all speculation in realty on its own. There is enough black money in the economy to stymie the RBI.
Conversely, what lies outside the banking system is beyond the control of the RBI. The prolonged bout of inflation, for example, had its origins in excess government spending, which the RBI can partially restrain by raising rates, but a larger part of the price rise came from government actions such as raising minimum support prices for foodgrain heftily in 2008 and later, et al. These raise prices directly.
The second thing to note is that the RBI can act on the demand side of inflation, but not the supply side. If prices rise, the RBI can raise rates or restrict credit directly to some sectors or even the whole economy so that demand is damped down. But if supply stays constricted, this won't be enough to curtail inflation. Only government action, and the right incentives, can increase supplies to reduce prices. Inflation in recent years has been driven not by rice and wheat, but protein-based foods such as milk, veggies, eggs, meat, pulses, etc - where demand cannot be constrained any further by monetary measures. You have to increase supplies to bring down prices. The RBI can do nothing about that.
The third thing is that the RBI cannot do much about business confidence. A key reason why the economy is slowing down is that businessmen are not keen on investing due to uncertain policies and court interventions in various sectors - from mining to spectrum - resulting from executive failures. The RBI can, of course, improve economic confidence by running stable policies and bringing down inflation, but this won't work if the government inspires no confidence. Also, whatever the RBI does to curb inflation can be undone by the government. For example, you can't bring down real estate prices if a Land Acquisition Bill seeks to restrain land supplies by artificially jacking up how much should be paid for acquired land.
The fourth point is that the global economy can have an impact on us, RBI or no RBI. If Ben Bernanke starts reducing bond purchases and raises interest rates, capital will flow out. The RBI can at best try to stem the outflows by raising interest rates - but this will work only in the long term. It is only by being an attractive long-term destination for investment that capital flows will be less volatile. That lies in the government's domain.
William Pesek of Bloomberg, in an article titled "India's new central banker isn't a superhero," tells us why Rajan will not find it easy to live up to his first day star rating. His essential point is this: both Manmohan Singh and P Chidambaram will be in election mode, and this means the support that Rajan needs in terms of policy action will be lukewarm or altogether missing.
Pesek writes: "The man who must address the core problems, Prime Minister Manmohan Singh, is a spent force." And Chidambaram? Pesek agrees that he "understands India's troubles as well as anyone. But he is a possible successor to Singh should the Congress party win at the polls. That means that the two men most pivotal to India getting its act together probably won't be doing anything bold or creative between now and then (i.e. May 2014)."
This is why he feels Rajan is in for serious disappointments as real reforms will be delayed till after the elections. His dismal conclusion: "For the next nine months, India's rot will only deepen. That's about 270 days to hit new lows on the rupee and for rating companies to mull downgrades. Wasting this time might seem less irresponsible if India had enjoyed a surge of reformist energy in the last 10 years. Instead, it's been a lost decade for change."
Rajan can't fix in weeks and months what the UPA was busy ruining over nine-and-a-half years.
Updated Date: Dec 20, 2014 22:59:11 IST