The verdict on Raghuram Rajan’s two years as the RBI governor

Going strong.
Going strong.
Image: Reuters/Danish Siddiqui
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Emperor Napoleon is reported to have told his secretary Baron Fain, “In war, luck is half of everything.”

During his first two years in office, Raghuram Rajan, the Reserve Bank of India (RBI) governor, has had luck firmly on his side as he fought to tame the inflation dragon. When Rajan took office on Sept. 04, 2013, India was in an economic crisis, with the rupee having depreciated sharply, the current account deficit having widened to an alarming extent, and inflationary pressures still high.

As the RBI had been attempting to smooth the rupee’s sharp depreciation during the first half of 2013, India’s foreign exchange reserves had also been significantly eroded.

It has been the country’s good fortune to have such a capable economist with the highest international credentials taking the helm at the RBI at a time of economic crisis. With Rajan’s background as a former International Monetary Fund chief economist and a professor of finance at the University of Chicago, his appointment as the RBI governor was celebrated by Indian and international financial markets.

Looking back at his first two years in office, Rajan has had remarkable success in managing the monetary policy and rebuilding India’s foreign exchange reserves.

Helped by the collapse in world oil prices, the consumer price inflation (CPI) rate in India has dropped from a 9.5% in August 2013 to just 3.78% in July 2015—well within the RBI’s indicative target for CPI inflation to be below 6% by January 2016. Meanwhile, the wholesale price inflation rate has declined from 6.1% in August 2013 to -4.05% by July 2015.

With inflation at bay, Rajan has eased the monetary policy with three rate cuts so far during 2015. If near-term inflationary pressures remain subdued, there is a good case for additional monetary policy stimulus to help boost the economic recovery.

Blames and challenges

If there is an area where Rajan has been subject to criticism by the Bharatiya Janata Party (BJP) government and the Indian industry, it is that he may not have cut policy rates fast enough given the slowdown in inflationary pressures.

This is of particular concern given the pace of India’s economic growth is still well below its potential growth rate of at least 8-9% every year. However, the BJP government must also take its fair share of blame, since its new gross domestic product (GDP) statistical methodology and data revisions introduced in 2015 have given the impression that the Indian economy is performing better than many high frequency indicators such as industrial production would indicate. This has complicated the RBI’s job of reading the true pace of underlying economic growth.

Meanwhile, Rajan’s task of rebuilding foreign exchange reserves has been helped by the slump in world oil and gas prices, which has significantly lowered the cost of Indian imports and allowed the current account deficit to narrow from 4.8% of GDP in 2012-13 to just 0.2% of GDP in the January-March quarter of 2015.

The election of prime minister Narendra Modi in May last year provided an additional boost to reserves. A surge of foreign portfolio capital inflows into the stock market during 2014 helped improve the country’s capital account inflows.

Foreign direct investment inflows into India have also risen sharply, up by 40% in the 2014-15 financial year to $34.9 billion. As a result, foreign exchange reserves have grown from $275 billion in August 2013 to a new record high of $355 billion by August 2015, a net gain of $80 billion under Rajan’s watch.

However, with world financial markets in turmoil following the Chinese stock market crash and Chinese yuan devaluations, the RBI governor cannot rest on his laurels. He will face tremendous challenges in the months ahead, particularly with the US Federal Reserve likely to commence raising US policy rates for the first time since 2007.

After sailing with fair winds during his first two years, governor Rajan’s skills at navigating storms and tempests in the global economy are now likely to be tested.

Rajiv Biswas is the Asia-Pacific Chief Economist at IHS.

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