Aseema Sinha on whither the Indian economy after Raghuram Rajan leaves India’s central bank

Dr. Aseema Sinha is the Wagener Chair of South Asian Politics and George R. Roberts Fellow at Claremont McKenna College’s Government department. She was previously an associate professor at the University of Wisconsin-Madison and a Fellow at the Woodrow Wilson Center in Washington, DC. Professor Sinha received her B.A. from Lady Shri Ram College. Dr. Sinha received her M.A. and M.Phil. from Jawaharlal Nehru University (New Delhi, India). She received an M.A. and Ph.D. from Cornell University. Her research interests relate to political economy of India, India-China comparisons, international Organizations, and the rise of India as an emerging power. She spoke to Shivani Pandya CMC ‘18 on June 29, 2016.

In your opinion, what has Governor Raghuram Rajan accomplished since assuming office in 2013? Are there any critical issues he would have wished to address more?

Governor Rajan’s achievements are clear in controlling inflation and in managing India’s foreign exchange flows with great skill. When Rajan became Governor in 2013, inflation was very high, around 9.8% in 2013, and the currency was very volatile. Growth was very low. Rajan kept inflation low by keeping interests rates high. Rajan also started using Consumer Price index (CPI) as the key indicator of inflation, which is the international norm, although the government was not too keen to do so. Also, under Rajan, India’s foreign exchange reserves have rebounded to reach $380 billion. Now, maintaining growth cannot only be attributed to Rajan because there are many factors that go into growth. That said, Rajan has certainly stabilized the fiscal and monetary policy of India. So, he has had a very significant policy impact, and he has done so in the face of criticism and some challenge to his position. In effect, he has used his credibility to shape monetary policy. 

In addition to inflation rates, there is something more significant that Rajan has done, which most people don’t focus on: Institutional reforms in the way interest rates are determined. First, of all, he has insisted that the government keep its target of 3% fiscal deficit by 2018 as outlined in the government’s commitment under the Fiscal Responsibility and Budget Management law passed in 2004. There was some tendency on the part of the Modi government to relax the goal of fiscal stabilization but Rajan resisted that impulse. Second, he suggested the idea of a “monetary policy committee” which is a regularized body. The idea is that it’s a group of people who decide interest rates, but also other aspects of monetary policy. He has negotiated with the government to give RBI equal space in that committee. He has managed to do a lot of things, and his credibility and global reputation has also facilitated more FDI investment in the country. 

Another big achievement of Rajan was to start reforming the banks and the non-performing assets (NPAs) of the banks. He made it a serious issue, put it on the agenda of the government, and suggested a broader framework to ensure healthier banks. RBI, under Rajan, started an “Asset Quality Review” of all banks, which forced banks to make their NPAs loans transparent. RBI also started to help banks by providing some financial tools to deal with bad loans such as conversion of bad debt into equity instruments, and turning over of bank’s management if needed. 

So, I would say Rajan has accomplished four critical things: Controlling inflation, setting up a institutional framework which goes beyond him, providing a stable environment for foreign institutional investors to think of India as an attractive destination, and initiating serious banking reform.

There were rumors of rising tensions between a Modi government faction (BJP Hindu nationalists) and Rajan. In your opinion, to what extent did those tensions play in Rajan deciding not to pursue a second term? 

Just to be clear, a majority of the headlines surrounding controversy are about Subramanian Swamy’s statements on Rajan. 

So, there are two different views of the tension between Rajan and the Modi — one is that the government wanted lower interest rates and Rajan was not willing to fulfill that. That’s a policy-oriented controversy. Again, the controversy you’re referring to is Swamy’s letter on the May 18th of this year (2016) where he wanted the government to fire Rajan. 

In my assessment, Swamy’s letter did not play a role in his resignation. The editorial pages are filled with speculation about how Rajan might not have liked what Swamy said, but I don’t think it played any role. Rajan was probably irritated, but he didn’t let it affect him. 

I saw a very interesting interview of him on June 8th in which Rajan actually makes light of the Swamy claim. So in my view, the Hindu nationalist views did not play a role in his resignation. Now, of course, these are merely speculations — only people close to him truly know. We know that Rajan’s father recently suggested that if the Modi government had supported Rajan in the face of Swamy’s criticism, then, he may have felt that the government was in his corner. His father has come out with a statement to that effect. My feeling is that the reason for his leaving is something else. Therefore, I don’t think it was Hindu nationalists or Swamy’s claim that ultimately led Rajan to resign. 

In my assessment, Rajan resigned because the government had decided to appoint the next RBI chief based on the recommendations of a search committee. This was announced on June 11th and Rajan’s resignation was announced on June 18th. Rajan felt humiliated that his performance will be judged by a committee. He felt that defending his performance in front of a committee was humiliating for him. This is my assessment but the real facts about his resignation are only known to people close to him. 

How has his announced departure affected India’s markets, and will this have any long term consequences, especially in terms of investors’ confidence in the Indian government’s ability to maintain a prudent monetary policy?

There was a short-term consequence — the rupee declined by 0.8% soon after he announced his resignation. The stock market did show a dip once they opened on Monday after he announced his resignation. But, the stock market bounced back; the rupee also came back to its earlier level. So in my view, it had some short-term impact but will have no long-term impact.

Now, your question about investor’s confidence — I don’t think Rajan’s resignation will impact it in the long-term. What will happen is that some people will now watch Modi’s policies more carefully. The finance minister and Modi will have to signal to outside investors that India is still a good place for investments, and they have to keep to targets that Rajan kept so ably (fiscal deficit, current account deficit, and inflation targets). So, they have to do additional things to signal credibility for the Indian economy, but I don’t think it will affect long-term investor confidence. On that point, I didn’t see any reports about any institutional investor withdrawing their funds. There may be a couple of investors who reconsider investing in India and there may be a short blip, but I don’t think it will have a long-term consequence. The fundamentals of the Indian economy — except for the NPAs — are strong. 

Naturally, global anxieties will rise if Modi continues to stay silent on this resignation. Why hasn’t he done so?

On May 16th or 18th, Swamy came out with that letter that called for Rajan’s firing. Arun Jaitley, India Finance Minister, responded that he had confidence in Rajan, but he made this statement on Twitter. Modi said nothing in response to the criticism against Rajan. That may have fueled this idea that Swamy could get his way. Then, when Rajan resigned on June 18, everybody assumed that Swamy’s letter had something to do with the resignation, and Modi continued to stay silent. 

Moreover, in an interview with the WSJ which was published less than a month ago, Modi indicated very strongly that the decision about Rajan’s continuation would be taken in an administrative manner, and said that there should be no political debate on it. So I think he’s trying to not respond to too many political arguments, and he’s saying, “I want to do my work. I don’t want to make a statement on everything.” He obviously may have miscalculated. 

On June 27, 2016, in an interview, Modi finally defended Rajan but it was too late. As consequence to Modi’s silence, Swamy took Rajan’s resignation as emboldening him, so he started to target other members of the Modi administration. That, and the whole global and domestic fallout about the perception that Swamy is dictating policy, has alerted Modi that his silence was a miscalculation. Once faced with the perception of this fallout regarding Rajan’s resignation, and Swamy becoming more emboldened, Modi finally responded to Rajan’s resignation and the surrounding events. I think it’s closing the stable gate after the horses have bolted! It’s too late. It’s possible that if Modi had spoken earlier, then Rajan wouldn’t have resigned. Modi’s strategy is to continue to do his work without getting into political controversy — because India has a lot of those — but he miscalculated in delaying it.

A particularly damaging impression is that “Rajan's departure is somehow related to his drive to clean up the balance sheets of state-owned banks, where political considerations have often interfered in financial decisions.” Is there any truth to this? 

It is certainly true that some people must have taken a sigh of relief when Rajan resigned. They may have thought that this is a good thing. I don’t think that anybody from the banking sector or people with these non-performing assets lobbied for Rajan to go. I think the real interesting thing here is the perception. There is an obvious perception that Rajan was strongly against crony capitalism, and he spoke out against Vijaya Mallaya, CEO of Kingfisher airlines, and others. Yet, he also said very clearly that we should not target all non-performing loans as crony capitalistic loans. He made it very clear that only a certain proportion of loans are lent to crony capitalists and the rest become non-performing for economic reasons. Thus, he was not making the point that all business is bad or all loans were bad. Again, I don’t think there was a specific lobbying by these people for Rajan’s resignation. The so called “crony capitalists,” or people benefiting from the loans, were not organized enough to lobby for Rajan to step down. These crony capitalists also understood that targeting Rajan would be pointless. To deal with bad loans Rajan has set up committees and an institutional framework for what banks should do in the future. So, reforms go beyond him. Even if he’s not there, the Indian government is committed to following these policies to reduce non-performing loans. 

This impression that you mentioned is interesting because there is a belief that the Indian economy reflects a nexus of business and politics. That perception could be damaging to the government, if the government does not do enough to prevent the non-performing assets from dragging the economy further. Rajan’s resignation in itself is not so important, but it may acquire significance if Modi’s performance on the economy does not improve further. Then, the perception that Rajan was hounded out either by Hindu nationalists or crony capitalists could damage the government

Are there any obvious candidates to replace Rajan? If so, what obvious challenges do they face in working with the Modi government. 

There are some candidates that the government is considering now. One is the chairman of the state bank of India and various other names. They are all respected individuals from the financial sector, which includes several economists. I think that anybody who is appointed as Governor would have a much easier task of continuing the policies set forth by Rajan. The only challenge they will face is of general elections and the incentives of the Modi government. In 2019, India will have its general elections. Modi has already started to campaign for that election. I think the challenge would be this dilemma of keeping interest rates low versus inflation while trying to create more schemes for varied sections of the population necessitated by the political business cycle in the next three years. 

Rajan was keeping interests rates high so that he could actually reduce the inflation. Obviously, the government would like to keep interest rates low and for economic growth to increase because then they would be able to use most of that growth to fund social schemes. As the government nears the election of 2019, it wants higher growth rates and potentially some more flexibility in monetary policies. And so, anybody who steps into Rajan’s shoes will face the same challenge of figuring out how to keep inflation low since that requires higher interest rates. Now, the government is very sensitive to inflation, but as they near the elections, their priorities shift a little — toward higher inflation and higher growth. Therefore, I believe the challenge faced by the new Governor would be to achieve a balance between growth and low inflation in a politically charged atmosphere where the government would like more revenues for its varied schemes.

Shivani Pandya CMC ‘18 Student Journalist
Featured Image Source: "Liaquat Ahamed and Raghuram Rajan" by Financial Times (Flickr: Liaquat Ahamed and Raghuram Rajan) [CC BY 2.0 (], via Wikimedia Commons
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