The global economy in 2016 is mired in very tepid nominal GDP growth. Gloomy debates about currency wars and available policy tools are endless even in forums like the G7 and G20. Clarity of message and consistency of policy are sorely lacking in the field of monetary policy today, but the RBI under Raghuram Rajan stands out and shines.
While the Federal Reserve, Bank of Japan and European Central Bank hold global sentiment hostage with changing goal-posts and unconventional monetary policies, the RBI’s recent introduction of a straightforward, orthodox, inflation-targeting regime is already proving its ability to influence Indian consumer prices. Additionally, Rajan’s guidance on a range for “positive real rates” gives investors a range to expect for nominal interest rates, something very few emerging market central banks have done. This is a huge change for a country which, historically, has been plagued by large fiscal deficits — one could argue almost to the point of “fiscal dominance” — and a persistent and stickily-high inflation rate. While plunging oil prices and global disinflation have unquestionably played a vital role in the reduction in Indian inflation, Rajan deserves full credit for the relentless focus on inflation control and his attempts to institutionalise a monetary policy committee process to ensure we stay on this course.
While the strict practice of inflation targeting can be maligned for its short-term effect of muting economic activity through high interest rates, the medium-to-long term benefits of controlling inflation and anchoring inflation expectations are manifold. Indians are sensitive to consumer prices, and the relative volatility of the latter has repercussions not only for household consumption behaviours but can also trigger socio-economic discontent. It is, therefore, essential to look past the interim effects of prudent monetary policy to ultimately reap its positive growth and sociopolitical dividends.
To address the questions of critics who point to India’s tempering growth rates in recent times as a sign of a need for change at the RBI, India’s growth must be put into global perspective. Global growth has been on a secular decline in this last economic cycle, with Europe and Japan struggling, the US barely growing, and even giants of rapid, consistent growth rates like China displaying dramatic decline in both real and nominal growth rates. In contrast, Indian growth has been resilient, growing much faster than the majority of its emerging markets cohort. RBI’s policy credibility has played its own role in this resilience by attacking the pernicious problem of inflation and fostering international confidence in Indian financial assets.
In working to encourage economic growth, Rajan has also been very aware of the impending risks an undisciplined fiscal account can pose to growth and inflation and to the Indian sovereign’s credibility in foreign eyes. By explicitly linking future monetary policy to fiscal consolidation objectives, he has been able to exert commendable influence on fiscal outcomes. The importance of fiscal prudence in emerging markets cannot be overemphasised, with budget discipline rewarded by raters and international investors alike. The spectre of fiscal dominance has also loomed large in recent times in India, with the risk being, like in Brazil, that monetary policy is dictated purely by fiscal realities and to the neglect of inflation. Yet credit is due here too to Rajan in delineating monetary policy as separate from the pull of fiscal dominance — the inflation-targeting regime is a case in point of this independent ideology. The rupee and its brilliant relative performance in terms of stability and absence of volatility since 2013 is testimony of what the global investor base thinks of the RBI’s policy stance on these vital issues.
As a complement to the careful eye Rajan’s RBI has placed on the government’s efforts at fiscal rectitude, there has also been a sorely-needed acknowledgement on his watch of how urgently the Indian banking system requires an overhaul, and a better understanding of how deep and concentrated the risks are that particular sectors pose to bank balance sheets. Rajan’s call for transparency and accuracy in the assessment and resolution of non-performing loans is bold and refreshing. Compare this goal for a more realistic diagnosis and a pragmatic solution, say, to the nebulous approach of China’s authorities towards its behemoth banking system, replete with murky inconsistencies, heavy underreporting of troubled loans and piecemeal resolution facilities.
In addition, Rajan has embarked on a spectacular transformation of the architecture of Indian banking and, in a broader sense, the Indian financial payments system. The vexatious issue of who should get banking licenses in India has been side-stepped into a new system of licensing different types of financial intermediaries. In the process, Rajan is attempting an audacious increase in bringing millions of Indians into the organised “payments” sector and away from the informal sector.
In sum, Rajan’s successes at the helm of the RBI have been a result of his consistent, market-savvy policy orthodoxy. The governor’s work is correctly aimed at stimulating the right kind of growth whilst remaining on guard for inflationary pressures, fiscal pitfalls and potential balance sheet crises at banks and private firms. He deserves additional time and space to see his existing policy stance bear fruit. To seek a replacement for his competence and credibility at this time would set the stage for a dangerous policy transition, especially at a crucial juncture when the whole world is currently at the mercy of monetary policy uncertainty. Policy continuity under Rajan is essential for India to weather the current global malaise of weak growth and advanced economy monetary policy uncertainty, while simultaneously building on the solid achievements made nationally on lower inflation, better fiscal discipline and a healthier banking system as a vital credit channel. He enjoys the confidence of the global investor community and is universally acknowledged for his master class competency in central banking and economics. India must lock in Rajan for another extended period of time to execute his vision.
(This article first appeared in the print edition under the headline ‘Carry on, Governor’)