Rajan warns capital outflows will test Indian economy

RBI governor expresses optimism that the central bank had 'done enough' to prepare for an imminent outflow of capital once interest rates rise abroad

Joel Rebello
Updated11 Aug 2014, 11:48 PM IST
Money and equity markets in developing countries are worrying over the consequences of the end of 0% interest rates in the US as growth, and hence inflation, there picks up in the next few months. Photo: Mint<br />
Money and equity markets in developing countries are worrying over the consequences of the end of 0% interest rates in the US as growth, and hence inflation, there picks up in the next few months. Photo: Mint

Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan on Monday warned that India “will be tested” by capital outflows once interest rates “start picking up” in industrialized countries.

Replying to a question after delivering the 20th Lalit Doshi memorial lecture, Rajan expressed hope the central bank had “done enough” to prepare for an imminent outflow of capital once rates rise abroad.

“I have no doubt that when rates start picking up in industrialized countries, we will be tested by capital outflows. My hope is that we have done enough in terms of strengthening the macro-economic framework and building up reserves to buffer up the economy,” Rajan said.

India’s foreign exchange reserves have climbed to near all-time highs of more than $320 billion, benefiting from huge dollar inflows this calendar year.

Money and equity markets in developing countries are worrying over the consequences of the end of 0% interest rates in the US as growth, and hence inflation, there picks up in the next few months.

Traders in India are particularly nervous because the last time US Federal Reserve indicated an end to its multi-billion dollar bond-buying programme in May 2013, the resulting outflows pulled the rupee down to a historic low of 68.85/dollar by August 2013.

Rajan said that the way asset prices have been “boosted” by central banks in the last few years, a flight of capital from developing countries is likely.

“Monetary policy is doing too much. Monetary authorities are boosting asset prices rather than the economy. Especially my colleagues in industrial countries are trying too hard,” he said, while suggesting that other parts of the developed countries’ economies should also contribute to reviving growth there.

Rajan said he expects capital outflows from developing markets to resume because asset prices “have been blown up for a very long time”.

“I was speaking with Ruchir Sharma (head of developing economies and macroeconomics at Morgan Stanley) and he was telling me that asset prices have risen at the fastest pace he has ever seen. There is clearly a disconnect,” he said.

In his prepared speech, Rajan purposefully batted for direct cash transfers to the poor to improve public services.

“Money liberates. Could we not give them cash to pay for their medicines and food, and command respect from the private service providers?” Rajan asked.

He said the RBI will “nudge” banks to offer simple financial products to the poor at a low cost and, at the same time, be profitable.

“Implementing cash transfers does not dismantle public services. It only means that they will pay (for services) and command respect. It is not a cure-all but will help people out of poverty,” Rajan said.

He said the RBI will work with the government on its new financial inclusion plan to be announced on Independence Day, Friday.

“We are already licensing payment banks and intend to move forward quickly. We have also released a paper on small banks which will be local in nature, serve local communities and employ local people,” Rajan said.

Rajan said the debate about crony capitalism in the elections just gone by means that concerns about it are real for the people today.

“Crony capitalism is harmful because it kills competition.... Our country suffers for the want of a few good men in politics.... Financial inclusion is important got for both the government and RBI in the coming years,” Rajan said.

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First Published:11 Aug 2014, 11:48 PM IST
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