Raghuram Rajan has begun with a bang. The new governor of the Reserve Bank of India (RBI) has done well to present a clear plan for the future on his very first day on the job. His detailed statement dealt with many issues. Here is a quick guide to what some of it means.
• Rajan came across as a man in charge. He spoke with authority. He made it clear that he was taking various decisions. This is a good start because it will send out a strong signal to the markets that a decisive man is in charge of Indian monetary affairs. He also set tight deadlines for various decisions, which means that there will be a flurry of activity on Mint Road in the coming months.
• It is clear that inflation control will be seen as the primary task of the central bank, not surprising for anybody who is acquainted with the views of the new governor. But Rajan also took care to add that transparency and predictability were attributes worth pursuing; the second is particularly significant given that the recent flip-flops during defence of the rupee has dented the credibility of the Indian central bank. “RBI should be a beacon of stability as to its objectives,” Rajan said, which must be music to the ears of detractors who complain that RBI keeps shifting the goal posts. Rajan also said that financial stability would be an important objective, which is in line with the in-house view of RBI. So he is not bringing a wrecking ball to the job, which is good given the deep understanding that RBI has of the complex Indian economic realities.
• Rajan sent out a clear message that the financial markets should not be seen as the enemy. He said they could be complements to the banking industry. He also warned against the old habit of shooting the messenger, through restrictions on trading. “We cannot create depth by banning position taking or mandating trading based on well-defined ‘legitimate’ needs... We will steadily but surely liberalize our markets, as well as restrictions on investment and position taking,” he said. The upshot: financial liberalization is back on the agenda.
• He also spoke boldly about rupee internationalization, through which international trade can be settled in rupees. This is something that China is also trying. The end game in that case will be full convertibility on the capital account, though that could be several years away given the fact that India has high inflation, a large fiscal deficit and an underdeveloped finance sector. But the very fact that Rajan put this on the table at the beginning of his tenure shows what could lie ahead. The statement about the internationalization of the rupee should be compared with the recent loose talk about imposing capital controls to protect the rupee to get an idea of how we could see fresh thinking on financial reforms in the coming months.
• One of the most important announcements in the Rajan speech was the setting up of a committee headed by deputy governor Urjit Patel to “come up with suggestions in three months on what needs to be done to revise and strengthen our monetary policy framework”. Such a rethink could be fundamental. There are two earlier examples: Manmohan Singh had appointed a committee, headed by Sukhamoy Chakravarty in 1984, that eventually set the framework for monetarism in RBI while Bimal Jalan quietly shifted to the eclectic “multiple indicators approach” in 1999. So Rajan could have signalled the third major shift in monetary policy thinking at RBI in the past three decades.
• One of the most contentious issues in recent years is what inflation gauge RBI should target. The central bank seems to prefer the Wholesale Price Index even though the inflation expectations of households are formed through changes in consumer prices. India has in recent months had greater success in bringing wholesale price inflation under control while consumer prices continue to rise at double-digit rates. By announcing the issue of inflation-indexed bonds linked to consumer price inflation, has Rajan unobtrusively indicated that he will be using consumer price inflation rather than wholesale price inflation as the primary target of monetary policy?
The main message from the impressive statement on Day One is that Raghuram Rajan means business—and that there will likely be a gale of fresh thinking at RBI.