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      Raghuram Rajan’s Travails      

Omkar Goswami


Bimal Jalan became governor of the Reserve Bank of India (RBI) in November 1997 amidst the Asian financial crisis. Up to August that year, the rupee (INR) had remained flat at around 35.75 per US$ (USD). In mid-August, a deputy governor talked it down at a conference of money market operators in Goa.

That and the chaos in Asia encouraged traders to borrow and short the INR. India’s foreign currency reserves were USD 22 billion. It fell by USD 3 billion in three weeks as C. Rangarajan, Jalan’s predecessor at the RBI, unsuccessfully tried to hold the exchange rate. When Jalan assumed office, the INR-USD rate was testing 39 and looking at going to below 40. I remember re-jigging the old Ashes ditty to: “From crashes to crashes / Bust to bust / If Korea don’t get you / Indonesia must.”

The traders greeted Jalan by driving the intra-day rupee to below 40. The new governor surveyed the situation for a while and then struck back. He dramatically increased the short term interest rates to force the shorting traders to make losses; and squeezed liquidity to boot. Soon, frenetic punting came to a halt. The INR quickly rose from a tad below 40 to around 38.25. Having proven that he can occasionally punish, but knowing that such retribution can be only for the short term, Jalan then let the INR drift. Which it did, crossing 40 in mid-May 1998 and settling at around 42.5 by December 1998.

Why have I started with this example as Raghuram Rajan prepares to become the 23rd governor from September? The first is that the RBI governor is neither Superman nor a Super-Minister. He has two sets of instruments: those controlling money supply, and those affecting interest rates. He can also play a limited role in moderating excessive exchange rate movements by trading dollars.

However, given the global scenario and bearish sentiments about India, and that we have USD 252 billion of foreign currency assets versus short term external debt of USD 97 billion, there isn’t much around to make big plays by selling dollars to arrest the falling INR. To assume that Rajan will halt the INR’s decline and simultaneously create a monetary stance that helps growth through cheaper credit flows is asking for too much. From anyone.

Second, Rajan knows that if the High Command is determined to pass the Food Security Bill (FSB), there is nothing he can do but watch and moan. In a well researched piece, Surjit Bhalla has estimated the FSB in its first year to cost Rs.314,000 crore, or 3 per cent of GDP. Even if it were halved, it will be staggering blow to the exchequer, and further weaken the RBI’s hand.

To maintain a sensible monetary stance that encourages growth and discourages inflation is difficult enough. Doing so when electoral political can wreck the fisc makes it the toughest job in India.

Third, more than other governors, Rajan must steer by good sense and instinct. In difficult times, Ben Bernanke showed exceptional qualities of being a great monetary helmsmen. Bernanke was not pursued by inflation. Rajan will have to reckon with that. So, more than others, he will need intuition, knowledge and calm to steer the ship, without any pre-set guidebooks to consult.

Fourth, many emerging market currencies have tanked. Between 2 April and 6 August 2013, the Argentine peso fell by 21 per cent versus the USD; the Brazilian real by 20 per cent; the South African rand by 23 per cent; the Indonesian rupiah by 11.5 per cent; and the INR by 16 per cent. The USD is moving out of emerging markets. In such a situation, it seems foolhardy to ‘save’ the rupee from falling. The best one can do is to occasionally temper the fall while focusing on sensible monetary governance.

That’s a very tough act in the backdrop of fiscal irresponsibility and political interference. Rajan deserves all the luck in the world.

Published: Business World, September 2013


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