Sept. 10--I was at the All American Diner at the India Habitat Centre (IHC) to meet India's latest superstar. But before we could settle down and begin the conversation, I realized that the ambience was a little too noisy for serious talk. I hesitantly asked the superstar if we could find a place somewhere outside to do the interview (I knew that I had limited time and that was the only restaurant at IHC where non-members were allowed). He agreed. Without wasting any time, we decided to go to the amphitheatre at IHC. My photographer colleague was noticeably pleased, but I was not sure if I had done the right thing. As we stepped out, it was predictably humid and, worse, I had little idea as to where exactly the amphitheatre was. Our star led the way and we obediently followed.
My guest that evening was Raghuram Rajan, then Eric J. Gleacher Distinguished Service Professor of Finance at the Booth School of Business, University of Chicago. Before the constant reminders from his publisher about his next engagement and a light drizzle stopped the conversation, Rajan spoke at length about fault lines in both the global and Indian economies, which are as relevant today as they were in August 2010. At the time, I, too, was interviewing him for the publication I used to worked for earlier, but then the excerpts are as relevant today as they were then. One question that I did not ask that evening was if he wanted to come back to India. I think I had a rough idea.
These are trying and testing conditions and markets have shown great faith in Rajan as the new governor of the Reserve Bank of India. His message has gone down well and markets have responded positively. I am not sure if his performance on the first day on his job at Mint Road would have won him votes, but new records on Facebook were certain. (Hint for New Delhi -- If you come with a sense of purpose, speak with confidence and inspire trust -- it makes a lot of difference.)
However, it is difficult to say if those "likes" would have been sustainable. What markets like is not necessarily what the central bank is always supposed to do. The announcements made on 4 September came at a time when both the equity and the currency market were under stress and they rallied in relief. But as they move forward, the same old fundamental questions will come back to haunt. The solutions to the problem that the Indian economy and the financial markets are facing today has to come from New Delhi, not Mumbai. There is very little that any central bank or banker can do at this stage. This is not to say that the central bank cannot do anything. The Reserve Bank of India (RBI) can take a few steps which will help the economy, but it is unlikely to solve the fundamental problems that the economy is facing at the moment. For example, the step to allow Indian banks to borrow abroad and swap it with RBI is a good idea, but steps like these can stabilize the currency market only in the short run. The next few quarters will be intensely challenging for India. Apart from the pressure of dealing with a slower growth, as we approach the general elections, the uncertainly in the economy and the financial market will only rise. A large amount of foreign debt will also be maturing at a time when probably the US Federal Reserve will be cutting its asset purchase programme.
Interestingly, the government of India wants coordinated action among G-20 nations so that the impact of monetary correction in the US can be minimized on a country like India. Here is what Rajan said in the above mentioned 2010 interview: "It is very difficult to coordinate policies between countries as they feel that domestic policies are their business and the way they have defined areas as domestic is so nobody else has control over them. So even though the US monetary policy affects the world, they will call it their domestic policy."
On the monetary policy front, the new governor has done well by pushing the date of the review by two days to 20 September as it will allow the central bank to react, if necessary, to the decision taken by the Federal Open Market Committee, scheduled to meet on 17-18 September. But if you are looking forward to a cut in policy rates, you may have to wait a little longer. On the question of inflation and interest rates, here is what Rajan said in that interview: "You have to be very careful on the monetary policy front. You don't want inflation to take off in such a way that you need sky-high interest rates to pull it back. At the same time, you don't want to kill economic growth, where you'll be killing both demand and investment plans. In an ideal world, it would be okay to say 'let me hope that investment comes in on time, but till then I will shut down demand'. But if you shut down demand too strongly, you kill longer term growth. We need to recognize that we are reaching the limits of non-inflationary growth and the monetary policy has to become tighter over time."
End note: In these difficult economic circumstances, Rajan taking over as governor of RBI is a big positive for the Indian markets. However, very soon, the ball will again be in the government's court. Monetary policy will face the same dilemmas as it did until a few weeks ago. Further, the decisions on the financial sector reforms will have to be backed by government action. I am still not sure if New Delhi is ready to match the pace of change with Mumbai.