An electrical engineer from IIT Delhi (1985), and an MBA from IIM Ahmedabad (1987), Raghuram Rajan worked for the Tata Administrative Service for a few months before heading to the Massachusetts Institute of Technology for a PhD in finance. After 12 years in academics and co-authoring the bestselling Saving Capitalism from Capitalists, Raghuram joined the International Monetary Fund as economic counsellor and director of research in 2003. He has recently returned to teaching as Eric J. Gleacher distinguished service professor of finance at the Graduate Business School at the University of Chicago. In India for a few days, Raghuram met Sandipan Deb and P. Vaidyanathan Iyer in Delhi for an exclusive interview. Excerpts: How do you see yourself, more of Milton Friedman or Joseph Stiglitz? Friedman believed in the power of markets and that most problems could be solved by finding clever ways of making use of markets. By giving people and individuals a choice. For example, in education, can we try and give the power to choose the schools the poor want to send their children to, instead of saying the government will keep funding public schools. Can we give the poor vouchers to choose between private schools? Stiglitz more or less emphasises that markets don’t work that well. He feels markets fail far too often, so let’s rely more on the government. He would put more reliance on intervention than market forces. I myself think, there is a strong role for the market, but you cannot dispense with the government either. But the government has to be an enabling one. In that sense, I am with Friedman. Yes, markets do break down sometime. The government has to step in to provide things like insurance, social security. I take a middle view. Today, globalisation ensures that countries and governments are competing with each other, unlike earlier. Friedman was primarily functioning in a world where cross-border competition had broken down, post war. The government was overly strong. We are in a different world today. You have to fight it less internally. Cross-border competition is doing it for you. We need to find clever ways of making market work. For instance, in fair price shops, there is a huge amount of leakage. Ultimately, the poor do not get very much out of it. Why not trust the poor more? Give them the money directly. Write a cheque. The government must ensure, the cheque goes to the right person. That he receives it without much leakage. Also, the government must offer some support to help the people make reasonable decisions. If you have your children in school, you get a little more, if you offer nutritional support, you get a little more. This will help people take part in the economy. In your book, ‘Saving capitalism from capitalists’, you wrote there is a more serious danger to capitalism from incumbents, who do not want new comers. It is here the government plays a big role. Is the idea being debated more actively? In a sense, I was describing a process in which the power of incumbents was weakening to some extent. You still see it coming time and again. That process is going on and global competition is really helpful. To give an example, the other day Sunil Mittal was talking about how India would have been held back if we had given in to the Bombay Club. But now it was very beneficial, since we now have the Ludhiana Club. I think it would be even more beneficial, if in addition to the Ludhiana Club and the Madras Club and so on, we had in India the London Club and the Washington club. We have allowed foreign entry. But we still keep making conditions. Foreign entry only if you have tie-ups with local entrepreneur. Sometime it is beneficial since local skills are needed. Sometime, it just holds up the foreign investor and forces him to share 26-30 per cent with the local incumbent. Three years down the line, with the local incumbent providing nothing, he buys out the local incumbent. The guy has got rent, and walks off with a pile of money. We have to figure out where it makes sense. At this juncture, do you see inflation as a major issue? I think it is becoming a bigger issue. Think about the forces keeping inflation quiet. We have had very strong productivity growth in the economy. There has been more production for a given level of capacity. And also, there have been extremely disinflationary conditions with China coming in with cheaper products in some segments, certain amount of capacity unused partly as a result of boom-bust in emerging markets in late 1990s and partly as a boom-bust in developed markets, telecom, IT sectors, so on. Good factors in keeping inflation down. Also, low level of interest rates, also added to this process. Many of these are now reversing. Capacities worldwide, for example, getting used up, especially in industrial countries like the US and Japan. Investment has been relatively low given the amount of growth, which is contributing to the fact that capacity is tightening. A classic example is investment being low is in the energy sector, very low. As a result prices have shot up through the roof. Japan unemployment is now 4 per cent. Labour market is tighter around the world. And a variety of factors are turning around now. Given these, we should be worried more about inflation. Even the credit growth at about 30 per cent to certain sectors like commercial real estate are growing. Do you see the building up asset bubble? Less familiar with real estate market. Is it across the board or is it in pockets? If it’s in some narrowly focused areas, it is less worrisome. Again in tier II cities, incomes have gone up and credit to buy houses have gone up too. It is possible that house prices had dropped due to a poor market scenario. It’s not just the growth rate one has to be worried about. That said, whenever you have growth rates of this kind, you have to be worried. RBI has made right prudential intervention. There will always be people who say, you are stifling growth. But, in a sense, the job of the regulator is to find a balance. Part of the problem right now is that there is such a sense of euphoria in the country that even taking normal precaution is seen as totally anti-growth. The RBI is partly in this kind of position now. It’s saying, ‘Look, take care, let’s worry a little about inflation, a little about credit risk’. Everybody is saying, don’t spoil the party. And the stock markets too. They are at an all-time high in India. Interestingly, this is a worldwide phenomenon. We don’t give enough credit to the fact that all these good things are happening to the Indian economy when the world economy is also doing very well. The world output has seen very strong growth in the last four years. It is coincident with four years of growth in India. And also, financial conditions worldwide like long-term interest rates are still very low. Some of its spilling over to India. Foreign money is pouring into the country in the hope that it will get better returns here. Let’s not forget, India is part of the world story. So, if the world goes through a lean patch, then part of the impact will also be on India. In 2007, world growth is expected to be lower at 4.9 per cent compared with 5.1 per cent last year. Will India be affected? It’s only moderately low. As of now, there is no reason to believe that growth will fall off from a cliff. Even in the US, you put more of a weight on risk to inflation than to growth. Growth has picked up in Europe, emerging markets have picked up. So, at least, I see another year of pretty strong growth. So, it is now, we have to see if our growth is partly because of past policies, world growth, private sector restructuring in the late 1990s, interest rates low in world and domestically too. The missing link is current policies. Are we doing enough still to keep it growing 3-4 years from now, which is when we need growth? We must remember that growth in itself is not a story, sustained growth is the story. To get 40 years of 8 per cent growth, we need constant and very, very steady reforms. And, of course, no accidents. Interest rates look set to rise, but the government wants them to be low. The question is how much in the hands of RBI. It can control only short-term rates. The central bank has less control over long-term rates. Over a period of time, bank lending rates have to adjust. The assumption that lending rates will be independent of inflation, is a wrong one. Hence, we need to keep inflation under control. Hence, RBI needs to focus on keeping inflation low.
