Raghuram Rajan deserves everyone’s congratulations on his elevation to the Reserve Bank of India’s (RBI’s) governorship. Having a doctoral degree from a top school is a rarity among India’s policymakers. Rajan earned a PhD in finance at MIT’s management school in 1991 for a thesis titled Essays on banking, having to do, we are told, “with the downside to cozy bank-firm relationships”. He has been president of the American Finance Association. During Anne Krueger’s reign as first deputy managing director at the International Monetary Fund (IMF), he held the top research position there once held by the late Michael Mussa. Rajan has thus come to be well-known over the last decade in the West’s financial media. Given the dismal state of India’s credit in world capital markets, it is an asset for a new RBI governor to have.
A simple question, however, needs to be addressed clearly and soon: did Rajan at any time in his American career renounce his Indian nationality and swear the US’s naturalization oath? If he is an American, the government of India may even so cite the new precedent set by the venerable Bank of England that recently appointed a Canadian as governor.
Specifically, will he need a tutorial on rural India’s credit markets, and their relationship with the formal monetized sector? India is a labour-abundant country which should have a relatively low world price of labour and relatively high world price of capital. Nominal interest-rates have been tightly regulated for decades and arbitrage profits are still made by trading these artificially low rates of money interest against the very high real rates of return on capital in the informal sector. (Joan Robinson once explained “the difference between 30% in an Indian village and 3% in London” saying “side by side with the industrial revolution went great technical progress in the provision of credit and the reduction of lender’s risk”.)
Indeed, financial repression may have artificially switched the risk-premium—making it lucrative for there to be capital flight with real rates of return on capital within India becoming artificially lower than those in world markets. Just as enough export subsidies and tariffs can make a country artificially reverse its comparative advantage with its structure of exports and imports becoming inverted, so a labour-rich, capital-scarce country may with enough financial repression, end up causing a capital flight. The Indian elite’s capital flight out of India exporting their grown-up children and savings overseas has been likely induced by government policy itself. Will Rajan be able to comprehend this and stem or reverse it?
As the graph shows, India’s banks may have weakened dangerously over the decades, being kept afloat by continual recapitalization from the government that owns most of them, using more and more of the soft inconvertible currency debauched merrily by planners and politicians. The nationalized banks with their powerful pampered employee unions, like other powerful pampered employee unions in the government sector, have been the bane of India, where a mere 30 million privileged people in a vast population work with either the government or the organized private sector. RBI’s own workforce at last count was around 18,000. Will Rajan know how to bring some system out of the institutional chaos that prevails in Indian banking and central banking?
Rajan has apparently said, “We do not have a magic wand to make the problems disappear instantaneously, but I have absolutely no doubt we will deal with them.” Of course there are no magic wands but there is a scientific path forward. It involves system-wide improvements in public finance and accounting using modern information technology to comprehend government liabilities and expenditures and raise their productivity. It also involves institutional changes in public decision-making like separating banking and central banking from the treasury while making the planning function serve the treasury function rather than pretend to be above it. It is a road long and arduous but at its end both corruption and inflation will have been reduced to minimal levels. The rupee will have acquired sufficient integrity to become a hard currency of the world in the sense the average resident of, say, rural Madhya Pradesh or Mizoram may freely convert rupees and hold or trade foreign currencies or precious metals as she pleases.
India signed the treaty of Versailles as a victor and was an original member of the League of Nations, the United Nations and the IMF. Yet sovereign India has failed to develop a currency universally acceptable as freely convertible world money. It is necessary and possible for India to aim to do so because without such a national aim, the integrity of the currency continues to be damaged regularly by governmental abuse. An RBI governor’s single overriding goal should be to try to bring a semblance of integrity to India’s money both domestically and worldwide.
Subroto Roy was an adviser to Rajiv Gandhi in 1990-91. Comments are welcome at email@example.com