Can Rajan make a difference as RBI Governor? - YES

While much of the conjecture on what Raghuram Rajan will do differently has been on monetary policy, little attention has been paid to his core competence in banking systems and regulation, where he has made a major contribution. Having authored the Report on Financial Reforms and gone through the financial crisis advising what to do, he would be expected to take the Indian banking system to a new level, given the twin goals of meeting the regulatory challenges while bringing about financial inclusion.

On the side of monetary policy, there is a lot of guesswork especially within India Inc, given the impatience at the current interest rate policy. However, monetary policy options are always driven by theory and presently it is not known whether Rajan is a monetarist or Keynesian or follower of rational expectations. Normally it is difficult for any central bank Governor to be committed to any specific school of thought, as the response is always situational.

Continuity, alongside tweaks

Today the currency is the major challenge and the present stance is that a free fall is not advisable as it is destabilising and therefore, intervention is necessary. All options, such as curtailing liquidity, restricting advances for gold, discipline in derivative trading and intervention through currency sale, have been tried out. If anything more has to be done, then it will have to be more of the same, or similar indirect options. Therefore, till the rupee stabilises, it is unlikely that the die can be cast on the growth-inflation trade-off. The only change in approach can be that we allow the rupee to slip to what the market dictates, which is not presently the RBI’s stance.

Today, inflationary expectations are high as the impact of rupee depreciation has not yet been felt on core inflation. Yet, Raghuram Rajan can take a call that the present conservative monetarist approach to policy has not quite brought inflation down and therefore, we can move the trade-off to a higher level by lowering interest rates. Anecdotal experience in the last year shows that lowering of the repo rate has not quite brought down lending rates.

Therefore, there is weight in the argument that if high levels of interest rates have not brought down inflation, lowering the same has also not brought about growth. This will be the conundrum for the new Governor.

He has already indicated that he does not have a wand. Lowering rates in the next policy cannot be ruled out to provide a fillip, but it may not keep the engine going forward. Given that monetary policy is only a facilitator and one of the many factors that bring about growth, continuity in general with tweaks here and there could be the short-term response.

The author is Chief Economist, CARE Ratings. Views are personal

Also read: Can Rajan make a difference as RBI Governor? - NO

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