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Dear Dr. Rajan,

The latest round of data might have, perhaps, brought a bit of headache to you. But I doubt that, since I feel that you know, both in your heart and in your head, what to do. It is just a question of packaging.

I think the political obstacles have become a lot easier for you, after the latest round of state assembly elections. The Congress government has been reduced to a lame duck status. The other party (or, parties in waiting) will not mind more bad news coming out just now so that they can claim credit for the upswing.

I was at a seminar in Delhi recently and there I said that, if I were you, I would do a “Paul Volcker" on India. Yes, Volcker inflicted a double-dip in two years but, I think, he also paved the way for the next 18 years of expansion, save for a brief recession in 1990. You can repeat the same feat for India.

The inflation data gave you a good justification for raising the policy rate by 50 basis points (bps) each in December and in January.

I doubt if it will make a big incremental difference to industrial production or capital formation. Both are down for different reasons, reasons more important than the interest rate. Fiscal dominance is the most important reason. Of course, there might be a psychological impact (for the worse) and that might be good for the long run.

So, while a policy rate increase might not dent output much, it could cause a big dent in India’s inflation expectations, for the better, of course.

It would, most certainly put paid to any notion—howsoever far-fetched or near-fetched—that the Congress party might have entertained, of announcing populist schemes before the elections.

Here are further reasons for such a guess:

(1) To the extent that there is a marginal negative impact on demand, it would lower tax revenues further and the government will become more acutely aware of the fiscal deficit constraint in undertaking populist measures.

(2) Rating agencies will be quick to take note of the revenue implications of your rate increase and, hence, will react quickly to any government largesse to the public with a downgrade. I doubt if the Prime Minister and the finance minister are ready for that. They would back off.

(3) In any case, the election results have marginally strengthened their hands vs. the National Advisory Council and Sonia Gandhi. You will be strengthening their hands further in keeping the “forces of fiscal populism/recklessness" at bay.

As for financial markets, if Indian stocks slide, all the better. The threat of “tapering" or any other such adventurism on the part of the US authorities inflicting greater damage to Indian asset will be reduced if they had already fallen.

If anything, lower prices combined with a more stable currency might bring in more investors for the long haul, even if the US Fed was to taper in a big way (I doubt that would happen, in any case, under Janet Yellen).

Real estate prices will drop further and that can only be good news for a dysfunctional market where inventories are high and so are prices! Potential buyers will be grateful to you.

From the long-term perspective, for India to grow, it does need to do so after taking a harder look at the growth foundations. The last cycle began well but ended up being an unsustainable one as fiscal expansion and abundant capital flows led to indiscriminate and unproductive expenditure. That is why both potential and actual growth rates have declined considerably in recent years. Hence it was no surprise that two years of high growth (2006-07 and 2007-08) led to inflation.

To an extent, the corporate balance-sheet purge of 1998-2002 laid the foundation for the boom to last from 2003 to 2008. Similarly, another purge is needed—both at the government and at the corporate level. I do not know how many big corporations have undertaken a serious look at their balance sheet and external borrowings in the last several years.

While you may be helping their repayments with a stronger rupee (consequent to the rate action), the demand attenuation, if any, will force a hard relook at their business model (and, I hope, practices too).

So, if I were you, I would go ahead and do a 50 bps rate increase in the monetary policy meeting next week and in the January meeting. That does not sound that radical, I think. I was tempted to recommend a 75 bps increase next week but even I am brave enough only to be a “practical (arm-chair) revolutionary".

India needs a Raghuram Rajan-Paul Volcker, to force genuine structural reforms on India’s public and private sectors. With politicians distracted and powerless for now, you have a unique opportunity to hasten reforms with monetary policy. You should not let India’s stagflation crisis go waste.

Best wishes for next week and for 2014.

V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at To read V. Anantha Nageswaran’s previous columns, go to

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