50, handsome and hugely qualified, Raghuram Rajan was hailed at India’s first wunder-kid governor of the Reserve Bank of India (RBI). So delirious were the scribes with the looks and body language of the youngest governor, that they set him up to hit half a dozen effortless sixes in his first over. Rajan even looked the part. He didn’t play a single wrong stroke in his first press conference and talked of financial sector reforms. Many reporters really didn’t know what these actually might be. But it didn’t matter. Everything was upbeat after his predecessor, Duvvuri Subbarao.

The governor’s honeymoon lasted 17 days. It ended on mid-day of Friday, 20 September 2013 with Rajan’s first monetary policy announcement. After Ben Bernanke had put a hold on QE tapering which made stocks shoot through the roof while strengthening the Indian rupee (INR), his Indian counterpart announced an unanticipated 25 basis points (bps) hike in the repo rate to 7.5 per cent.

Although Rajan rolled back some earlier liquidity tightening steps, the press went ballistic. ‘Rajan brings on a Hangover’ headlined The Economic Times; ‘Inflation-wary Rajan skips Fed party’ wrote the Business Standard; Reuters called him an ‘Inflation hawk’; and ‘No steam for the growth engine’ said India Inc.

Now that our affair with the new governor has come to an end, it may be useful to make four basic points which might suggest future directions that the RBI could take.

The first has to do with QE. Irrespective of the US Federal Reserve deferring the QE tapering on 18 September, the fact is that the party must come to an end sooner rather than later. In August 2013, US unemployment was 7.3 per cent. It should fall below the 7 per cent mark by the end of the year, or by early 2014. That will certainly trigger change. If anything, one should be prepared for the tapering by November 2013. When it is announced, be ready for another outflow of dollars to the US and a resultant depreciation of the INR.

The second is inflation. Wholesale price inflation (WPI) was 6.1 per cent in August 2013, up from 5.8 per cent a month earlier. Consumer price inflation was at 9.5 per cent. Despite good monsoons, there is a sense of a price uptick — on account of vegetables and fruit and, more importantly, due to higher fuel costs because of firm crude oil prices and depreciation of the rupee. Rajan has reasons to be skittish in an environment where the WPI inflation remains resolutely above the ‘safe’ rate of 5 per cent. Its is debatable whether raising interest rates can supress primary product or fuel inflation. But since the RBI can only play with what it has, I wouldn’t be surprised if one sees higher rates in the offing if WPI inflation were to cross 7 per cent and trend upwards.

The third is the fiscal deficit. I have tremendous respect for finance minister P. Chidambaram’s determination to hold the deficit for 2013-14 at 4.8 per cent of GDP. But I doubt if he can — thanks to higher cost of crude and naphtha, low growth affecting tax revenues and an additional outlay on food subsidy to demonstrate that the Food Security Act is being implemented. If Chidambaram can keep it to last year’s 5.2 per cent of GDP, he will have done well. That will cost an extra Rs.45,200 crore.

The fourth is autonomy. Since Y.V. Reddy, successive RBI chiefs with some of the deputies have vigorously defended their policy-making turf, much like Beckett as the archbishop of Canterbury. On several occasions, the defence has been ‘we, the prudent’ versus ‘they, the prurient’. This dichotomy, though occasionally useful, needs to make way for better dialogue between the RBI and the finance ministry. But I doubt it.

Given these four forces, I wouldn’t bet on an accommodative or expansionary stance of the RBI in the next few quarters. India Inc. and North Block better look elsewhere for solace.

   
Published: Business World, October 2013