What does Bernanke’s decision mean for Raghuram Rajan?

Bernanke has invited Rajan to the party. He should join it

Krishna Merchant
Updated19 Sep 2013, 10:08 PM IST
The Reserve Bank of India governor Raghuram Rajan. A recouping rupee, a pick up in foreign fund inflows and a shrinking current account deficit give Rajan all the reasons to roll back the liquidity tightening measures. Photo: Bloomberg<br />
The Reserve Bank of India governor Raghuram Rajan. A recouping rupee, a pick up in foreign fund inflows and a shrinking current account deficit give Rajan all the reasons to roll back the liquidity tightening measures. Photo: Bloomberg(Bloomberg)

The markets expect Reserve Bank of India (RBI) governor Raghuram Rajan to start the process of rolling back the liquidity tightening measures announced on 15 June. He need not do it all at one shot; after all, he also has to keep an eye on what other countries that have raised interest rates do. But Rajan could do it partially, watch the reaction and then continue.

add_main_imageWhy should he start the process? Because the rupee has recouped much of its losses. Because the current account deficit (CAD) is now much lower than earlier. Because RBI had said, at the time of introducing the measures, that they would be temporary. Most of all, he should start rolling back the measures because they have increased the cost of funds for businesses and growth is suffering. It’s curious that State Bank of India raised its lending rates a day before the RBI policy meeting. Why it could not wait another day is a mystery.

The central bank should also start loosening policy because foreign fund inflows are likely to pick up and they will ease the pressure on the rupee. Foreign institutional investors have already turned net buyers and on Thursday, provisional National Stock Exchange data shows they bought a net 3,543 crore in the equity cash market. Sure, inflation is high and Rajan has said he doesn’t care about the source of inflation, but he should realize that monetary policy can do little about food inflation.NextMAds

The bigger question is why US Federal Reserve chairman Ben Bernanke held back the tapering. After all, the markets had already priced in a $10 billion or so of cutback in asset purchases. Couldn’t he at least have gone in for a $5 billion taper? His decision suggests he wanted bond yields to come down even lower than the 2.8% or so they were at before the Fed announcement. As an academic who has devoted a lifetime to studying the Great Depression, Bernanke knew that tightening too fast had scuttled a recovery during the 1930s and he very likely didn’t want to go down in history as the man who made that mistake again. In sum, the tapering is likely to be long and slow. The Fed’s hope is that time will repair the US economy and it’s then that the tapering could start.

What does that mean for world markets? It probably means the withdrawal of liquidity will be so calibrated that its negative effects will be offset by improvements in the real economy and the Fed will stay its hand until it’s sure of that happening. If this interpretation is correct, it’s very good news for markets and suggests the current rally will sustain. Further, a recent survey of global fund managers by Bank of America Merrill Lynch pointed to a lot of cash on the sidelines as well as investors being net underweight on emerging markets. That raises the possibility of more money coming into them. In the second week of September, commitments to emerging market equity funds hit a 30-week high, as pointed out by fund tracker EPFR Global.

That is not to suggest that India’s structural problems do not need to be fixed. But in the short run, Bernanke has invited Rajan to the party. He should join it.

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First Published:19 Sep 2013, 10:08 PM IST
Business NewsMarketMark-to-marketWhat does Bernanke&#8217;s decision mean for Raghuram Rajan?

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