Millennium Post

Can rockstar Rajan do it?

Since he occupied the hot seat at the Reserve Bank of India (RBI) a few days ago, the country’s principal markets dealing in corporate stocks, government bonds, commodities, bullions and
foreign exchange have been showing somewhat irrational exuberance, according 50-year-old hallowed MIT doctorate and former chief economist with the International Monetary Fund (IMF) Raghuram Rajan a rock-star’s welcome. The market sentiment has turned bullish. It seems happy days are to be here again. However, time alone can tell what is in store for the Indian currency and economy, especially in few months down the line.

Many industry and marketmen consider Rajan as a miracle man who has the capability to rescue Rupee and the economy from the current gloom and bring cheers to all. Rajan, a suave unflappable economist of international repute, himself says he has no magic wand to instantly reverse the country’s depressing economic fortune. He has willingly stepped into the eye of the storm rocking India’s $2-trillion-plus economy, the world’s 10th largest, to protect its Rupee, stabilise its markets and put it back to top gear. He certainly has plans up his sleeves. This explains why the new RBI governor did not waste time to indicate some of the policy options he has to revive Rupee and how he wants to work with the government and market regulators in this regard to remove unnecessary confusion over duties and jurisdictions of each.

Rajan has quickly reversed controls on overseas investments by companies. Simultaneously, to pep up the foreign exchange reserves, the overseas borrowing limits imposed on banks have been doubled and provided exchange risk cover for NRI deposits. A special window has been created to meet US dollar demand of domestic oil companies. These policy changes within the realm of RBI clearly imply that the new RBI governor prefers liberalisation of forex rules to tightening their control to prevent panic sale of the Indian currency. These steps have, to some extent, won back the confidence of the markets and foreign investors helping both stock prices and Rupee bounce back.
Within just five working days of his assuming the new job, the beleaguered Indian currency, Rupee, recovered almost nine per cent from its rock bottom exchange rate of Rs 70 for a US Dollar. The Sensex, the 30-share sensitive index of the Bombay stock exchange (BSE), which had earlier come crushing down, gained some 1,600 points over five trading sessions. The government of India bonds too somewhat managed to recover partly their lost ground. The domestic price of gold had dipped by nearly Rs 3,000 per ounce from its peak at over Rs 34,000. Even speculators in the commodity market are clearly willing to provide moral support to Rajan and Rupee. The Indian currency had plunged nearly 20 per cent since May as Asia’s third-largest economy is suddenly made to confront its worst crisis since 1990-1991. Rupee had earlier tumbled about 10 per cent in four weeks since Rajan’s appointment was officially announced on 6 August.

The question is: how long will this euphoria last? Can Rajan really lift the markets and economy from current depressive conditions? There are no piecemeal solutions to the current economic problem – an aggregate result of excessive imports of luxury and high life-style items, limitations of India’s export basket and capabilities, huge short-term overseas commercial borrowings, large capital outflow towards foreign debt service, inadequate foreign fund inflow by way of direct (FDI) and indirect (FII) investments, high domestic borrowing rates choking investment and hurting corporate bottom-line, consumer price inflation and poor performance of the infrastructure, core and manufacturing sectors. Under such a depressingly complex  economic environment, RBI can act only
in limited manner to rev up Rupee and the markets while fighting inflation at the same time and looking for government fiscal support and fresh financial sector reforms. Markets are prepared to trust Rajan for the present. But, they need to trust the government as well and respond positively to its measures.

Blissfully, Rajan is aware of all that. He knows that he has to act fast to retain the current bullish market sentiment. Surely, he will soon interact with the government, industry, the banking community and markets. Will he take a leaf out of unconventional ways of the recently-appointed Bank of Japan governor Haruhiko Kurada, offering a massive economic stimulus package making money cheaper despite the inflationary trends? None knows, for sure. This year’s good monsoon in most parts of the country should help contain food inflation through the ensuing festival months. Cheaper money will boost industrial output and consumer demands. Markets and analysts are scrutinizing everything the RBI governor says and watching every step he takes for clues about his intentions. However, Rajan will certainly wait until after the US Federal Reserve meet on September 17th and 18th which may announce a pivotal shift in the latter’s stimulus programme including the proposed slow exit from the bond-buying scheme.

The earlier announcement of the withdrawal of US Fed stimulus for the country’s economic recovery in the face of its record fiscal deficit has boosted the US demand for traditional sources of funds. And, the US and other outside investors have been suddenly pulling out of emerging markets to invest back in America. It was one of the factors which unsettled the Indian stock market where US financial institutions are major investors. They were also nervous about sharp fall in the Indian currency’s exchange rate. However, the biggest and the most compelling factor behind Rupee’s recent collapse is the country’s massive current account deficit (CAD) of about $90 billion – the world’s third largest.

RBI could do little to prevent this, except probably putting some panic-raising and counter productive capital account restrictions, to contain CAD. Strictly speaking, the CAD management is the job of the government and not RBI. The next three weeks are very crucial for the RBI governor and for the markets. India’s busy economic season traditionally begins from 1 October, when demands for goods, services and funds from manufacturing, business and industrial sectors peak. It also ushers in the festival and marriage season boosting consumer demands and spending. The season lasts until April.

The preparation of a good busy-season credit policy is the fast major task before Rajan. The credit policy sets the mood of the markets and industry. By month-end, Rajan will also be ready with the list of new licencees allowing them to start commercial banking operations after a gap of over two decades. Most economists and market analysts think that Raghuram Rajan will prioritise currency stability and investment-friendly pro-growth monetary policy over inflation. It does involve some risk. Is ‘rock-star’ Rajan prepared for the experiment and its consequences, if any? That is a million-dollar question. World-wide, best of central bank bosses always belonged to the conservative school. Under these trying circumstances, will Rajan prove himself to be different? IPA
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