Raghuram Rajan, who last week delivered his final monetary policy statement as India’s central banker, was, to the irritation of many in New Delhi, generally considered a bit of a ‘rock star.’ Partly that was because he was unusually visible for a central banker; partly because under him the Reserve Bank of India came across as an island of competence in a country plagued with inept and uncommunicative policy makers. But personality aside, and despite some stumbles, it’s clear that Rajan will leave office next month with his record largely vindicated.
Perhaps most consequential was his hawkish approach to inflation. For months now, as India’s notoriously sticky consumer price inflation stayed low—helped along by slumping oil prices—Rajan has been the object of sharp criticism for refusing to cut interest rates. Some of the criticism from ruling-party law makers was quite intensely personal, and was allowed by party leaders to continue unchecked for a long time. Eventually—and unfortunately for India’s credibility—Rajan chose to leave the job before he was sacked.
Yet the latest figures for India’s consumer price index appear to justify Rajan’s caution. The inflation rate crept upward to almost 6.1% year-on-year in July, just above the RBI’s target—and well above the official target of 5% for March 2017. That was a two-year high.
And there are plenty of additional obstacles to contend with. For example, New Delhi decided last month to raise government employees’ salaries. Their basic pay will increase 250%, putting large amounts of extra cash into the hands of 4.7 million current employees, as well as 5.3 million pensioners. All previous such pay increases have had a sizeable effect on demand—and on inflation.
Then there’s the new goods and services tax. The GST, in the long run, will have a positive impact on inflation—it will end the double payment of taxes—but, in the short run, it might substantially raise taxes on certain services, which would push the consumer inflation rate higher too.
In other words, if the RBI is going to hit its 5% target for next March, Rajan simply couldn’t afford to be any less hawkish on interest rates. And he wasn’t: He addressed suggestions that, by not cutting rates further, he was “behind the curve” by sharply telling reporters that the criticism was “without economic basis,” and that inflation simply wasn’t that low.
Rajan showed similar determination in taking on the banking sector—particularly the lazy state-controlled banks that are still dominant in India—for failing to pass on previous rate cuts to borrowers. He accused them of finding one disingenuous excuse after another, and promised that among his last acts as governor would be regulatory changes to crack down on the practice. That’s a very good call—and it would be a fitting end to Rajan’s tenure, given that much of it has focused on trying to make state-owned banks more transparent and responsive.
Realistically, then, the outgoing governor has left his critics very little to complain about. He has, in some ways, made things easier for his successor. His laser-like focus on consumer price inflation to the exclusion of other goals has meant the rate-setting part of the governor’s job is no longer as complex as it was; in March, the RBI signed an agreement with the government to set a formal inflation target. Rajan also wasn’t particularly hawkish in his final monetary policy statement, compassionately leaving his successor some room to manoeuvre. He refused to commit the RBI to keeping rates unchanged, even though he feared inflation might creep up again.
Much will now depend on who Prime Minister Narendra Modi chooses to take over at the RBI. Many fear that he’ll choose someone more likely to listen to pleas from the finance ministry in New Delhi to ignore the inflation target and cut rates in an effort to stimulate an investment recovery, potentially undoing much of what Rajan has accomplished. In any event, Rajan’s successor will not have sole control over lending rates, as he has; from October, a new six-member monetary policy committee will take over that task. Rajan will be the RBI’s last rock star. Bloomberg