Market misreading Raghuram Rajan; bankers, industry beware

Perhaps for the first time ever, I could sit and listen to a full speech of a RBI Governor - whether current or past - without feeling the need to switch channels. That monetary stability would be hisNumero Uno objective came through clearly. Perhaps it is too early to call, but it might well have been Paul Volcker speaking!!

Ofcourse, the market largely missed his key observation and focussed on the other reforms that he initiated. Going by the reaction of the stock markets this morning, especially the gains in the banking index, I think the markets have completely misread his course of action. Though Raghuram did make it explicit that he did not view the job as a popularity contest and that we should be prepared for some hard decisions, the implications of the same has probably not sunk in.


Raghuram will liberalize the banking industry. Reuters

Raghuram will liberalize the banking industry and there's no doubt that it's going to be good for the industry as well as the consumers. Though in the longer run. But the immediate hard decisions that he referred to - increasing CRR, interest rates - are going to follow very soon. My guess is that he will push up the CRR from the current level of 4% to 10% and leave it there for good, reduce SLR dramatically if not abolish the same altogether, and increase the Repo rate by around 100 to 150 basis points - all in very short order. The bankers and the industry that is largely praising him today will soon turn against him. His observation that a central banker "starts at the height of their popularity" is likely to be very prescient and I was almost reminded of the opening lines from one of my favourite movies "American Beauty" - where it all goes downhill subsequently.

Despite the limited support that he is likely to receive from both within and outside, he needs to plough on. India does not have the time to educate the bureaucrats and the crony capitalists (the CII till date has been clamouring for rate cuts) -- that debasing the currency is a sure shot way to destroy the economy. While the rupee could afford the Reddy's and the Rao's over the last 10 years, these are indeed perilous times and showing your disrespect for capital is a guarantee to ensure that it doesn't come your way. We have seen ample evidence of that in the last few weeks, though our political class and bureaucrats would use the excuse of the supposed Fed tapering to mask their misguided adventures in populism.

So the banking index that is witnessing euphoria today is going to be butchered in short order and bonds are going to fare no better. Judging his opening comments, I am hoping he does atleast this much. & if he cannot do it early on, he is going to find it very difficult to do the same later on.

But I wish he doesn't stop at that. Because Raghuram will inevitably, sooner rather than later, be followed by a RBI Governor who thinks running the presses overtime is a solution to our problems - as has pretty much been the case for almost the entire history of the RBI. Just as a Paul Volcker was followed by Greenspan, and when you thought it couldn't get worse, we get a Bernanke, and when you think how it can get any worse, we get a Janet Yellen/Larry Summers - each step leading to greater and greater debasement of the currency as a solution to economic woes.

So the way out is to introduce a free market competing currency system to circulate alongside the Rupee. India is probably the only country in the world with a huge stock of gold, and that too in private hands rather than with the central banks, and this "barbaric relic dividend" shouldn't go unutilized. Instead of clamouring for controls on the import and sale of gold, permit gold banking with enough safeguards against confiscation by future governments.

It's perhaps expecting too much. But if Raghuram really does his job well, then the RBI will no longer need to exist in the form it is operating today and monetary policy would soon become a free market function. And therein lies the true test of sustainability - can Raghuram create an orderly decontrol of the very institution he is heading?

Updated Date: Dec 20, 2014 23:56 PM

Also See