During Midsummer week the Governor of the Indian central bank RBI (Reserve Bank of India), Mr Raghuram Rajan, visited Sweden and gave a well-attended seminar at the Stockholm School of Economics, co-arranged by SEB.
Governor Rajan is a superstar on the global economic scene. Born in Madhya Pradesh, he became famous as an iconoclastic Chief Economist of the International Monetary Fund. In 2005, at a celebration honouring Alan Greenspan, who was about to retire as chairman of the Federal Reserve, Rajan delivered a controversial paper that was critical of the financial sector – quite the opposite of Greenspan’s views. In that paper, “Has Financial Development Made the World Riskier?”, Rajan argued that financial sector managers were taking excessive risks and that a burst credit bubble might threaten the global economy.
The response to Rajan’s paper was negative. Former US Treasury Secretary Larry Summers called the warnings “misguided” and Rajan himself a “luddite”. However, following the 2008 financial crash, Rajan’s views came to be seen as prescient and Rajan himself lauded as a “rock star” of economics. His subsequent book on the crisis – “Fault lines: How Hidden Fractures Still Threaten the World Economy” (2010) won the Financial Times Book of the Year Award. I see it as one of the best books on how structural forces, such as widening income differentials and sloppy lending, created tensions that led to the crisis.
The former Indian Prime Minister Manmohan Singh later asked Mr Rajan to chair a committee on how to reform the Indian financial system. The report recommended a series of “100 small steps” to deregulate and open the financial sector. At the same time Rajan established himself further on the international arena, clashing with Nobel laureate Paul Krugman in a fierce debate over economic policy. While Krugman advocated easy money, Rajan claimed the need for structural supply-side reforms to make the economy more efficient.
So, when he became RBI Governor in 2013 Raghuram Rajan arrived with a clear agenda to reform the economy, bring down inflation and modernise not only the financial system but also monetary policy itself. Under Rajan, the RBI has adopted an inflation-targeting strategy, similar to that of most central banks in the advanced economies – although inflation in India started at a higher level, which is why the inflation target has been on a “glide path” to gradually lower levels; the target for the next fiscal year is 4 per cent.
After the massive election victory of Narendra Modi’s BJP, rumours swirled that Rajan was to be sacked – he was, after all, appointed by the previous, defeated government. But Modi, wisely, kept Rajan on his post, respecting the integrity of the RBI and its governor.
Dr Rajan has worked hard to transform both the central bank and the banking system as a whole. Gradually, the Indian financial sector is opening up, curbs on foreign banks have been lifted, and regulations are softened. Still, however, the banking sector is weak, non-performing loans are too high a share of the total portfolio, and Rajan’s old colleagues at the IMF keep issuing warnings about the frailty of the banking system.
On the inflation front, things are brighter. As inflation has fallen, the key rate has been brought down in several steps. At the Stockholm seminar, Governor Rajan vowed to continue the fight against inflation, claiming low inflation is necessary both for growth and social inclusion.
He was not too worried about potential negative effects on the Indian economy from a future US key rate hike. India is now much more resilient than it was just a couple of years ago. Foreign exchange reserves have grown. The risk of capital outflows seems to be manageable. Paradoxically, the present relative weakness of other emerging markets on the global arena in a sense strengthens India, which is less dependent on manufacturing and exports than many other countries in Asia.
What I personally found most interesting during the lively Q&A session was Rajan’s scathing attack on several Western central banks. They are competing to weaken their currencies in order to push up inflation – but such actions could lead to a “currency war” with negative global repercussions. Governor Rajan would like to see, he said, a stronger role for the IMF in preventing such competing devaluations – words that caught the attention of many Swedes in the audience, since the Riksbank recently has pursued weakening of the krona as a tool precisely to create inflation…