Discipline is not a natural trait amongst Indians. We do not like to be constrained by boundaries. We want to retain the freedom, for instance, to tell the Reserve Bank of India (RBI) Governor to reduce interest rates, even if we cannot distinguish cash reserve ratio (CRR) from euro currency. Heavens forbid if he chooses to ignore such a command.
One of the major criticisms against Dr Raghuram Rajan, the incumbent Governor of RBI has been his stubborn refusal to lower interest rates. While interest rates today are lower by 150 basis points (bps) compared to the time he took over, business and industry had always clamoured for lower interest rates. What Dr Rajan has done is to take away the personal element by introducing a data based, structured framework for determining interest rates. In a sense, fixing interest rates has become predictable and stable. As he has always maintained, business wants predictability more than low interest rates.
RBI has been given a target to achieve, by the government – 4% inflation plus or minus 2% (range of 2% to 6%). How does one expect a reduction in interest rates, if inflation is currently touching 6%? As long as inflation is high, RBI needs to fight it ruthlessly.
Some of us may remember Paul Volcker, the former chairman of US Fed, increasing the federal funds rate to as high as 20% in the late 70s and early 80s, in order to kill the monster of inflation forever. Growth in the US plummeted and even turned negative during that period. Since then, however, the US has never faced inflationary pressures. A short-term pain was essential for long-term gain.
Volcker was also called terrible names due to the impact of his anti- inflationary measures on growth rate. Today, he is a revered figure. Human beings are too concerned with the immediate future, without being concerned about the long-term negative impact of their actions or wishes.
There are two other factors that are keeping interest rates high in India. The extent of non-performing assets (NPAs) in public sector banks (PSBs) implies that these lenders can no longer carry out their basic function of financing. Constituting 70% of the banking sector, this places a significant constraint on the overall lending ability of the Indian banking industry. Resolution of NPAs is critical to get the banking sector moving again and reducing interest rates. Dr Rajan has initiated the process to clean up banking balance sheets once and for all so that banks can commence their business without the overhang of bad debts.
Interest rates on government’s savings schemes are stubbornly high. About 8% plus tax-free returns are available on provident fund (PF) and other schemes of the government of India. Some of them have tax saving features too. That places a limit on reduction of interest rates by the RBI.
Supporters of the current government, miffed with the RBI, would do well to remember that fighting inflation is good politics, besides being good economics. Historically, hardly any government has lost elections due to lower growth rate; plenty of them have had to vacate office due to spiralling prices.
There are many reasons why Dr Rajan is exceptional. I will speak about one of the least mentioned. His voice has been a consistently sane voice in an otherwise loud cacophony of meaningless clatter. Growth in the world over in the last few decades has been debt-induced. The crisis in 2008 was based on too much debt. Dr Rajan has been warning us, unsuccessfully it seems, against this debt-induced growth.
This has been his consistent stand over the years.
He has also advocated coordinated efforts on the part of central bankers. Actions of one central bank have an impact on other economies also. We were witness in 2013 to the turmoil in emerging market economies, as a consequence of a slightly hawkish statement by Janet Yellen, ironically at the time Dr Rajan took charge as Governor of the RBI. Conflicting monetary policies of different central banks will render them ineffective. He has been exhorting central banks to take a global view and not be exclusively fixated only on their own countries. Not surprisingly, earlier this year, he was adjudged the best Central Banker in the world by the Financial Times group.
Not many people display the courage to consistently speak against popular beliefs of the time. To have the grasp of economic issues like Dr Rajan and the integrity to be true to those beliefs is a rare quality. Sadly, such qualities are not appreciated in this country. Despite the fact RBI as an institution will survive Rajan’s exit (Rexit), I am not sure it is a good idea to lose him.
(Sunil Mahajan, a financial consultant and teacher, has over three decades experience in the corporate sector, consultancy and academics.)