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It is when the going gets tough that the tough have to get going. If the tough ride out a storm, it lays a good foundation for successful, long-term performance.

The technocrat and economist of international repute Raghuram  Rajan, displayed high level intellect and strategy in riding out the storm that hit India’s financial markets last summer, soon after he took over as Governor, RBI.  At the end of a year of his tenure, he has stabilised the situation and laid a good foundation.  But successful long-term performance and the attainment of visionary long-term goals for India’s economy and financial system are contingent on the political economy. The Governor himself seemed to be acutely conscious of this when he said recently that the economic discipline should be re-designated as ‘political-economy.’


Economic storm

It indeed was a perfect economic storm when Rajan took charge as Governor early in September 2013 marked by: (a)  a currency in free fall, falling more than 20 per cent in the space of two months; (b)  stubborn and rising double-digit inflation;  (c) collapsing investments and sliding growth; (d) enormous strains in the balance sheet of the Indian banking sector, as non-performing loans ballooned.

The select macro-economic indicators (Table 1) capture the essence of the overall situation, both when Rajan took over and now. For, he has only stabilised the situation and none of the long-term macro-indicators are structurally any better now.

As can be seen, while growth was sliding, overall inflation rose and corporate capital investments collapsed. Technically, this combination of economic conditions is termed stagflation. All these imbalances got reflected in the country’s external trade deficits through the course of the second half of the 2000s. The external deficit increased more than 100 per cent in 3 years. It then duly got reflected in the rupee coming under intense downward pressure in the foreign exchanges, with the local currency losing a third of its value between 2011 and August 2013.


Monetarily India is unstable

From a central banking perspective, the root cause of all the macro-economic problems is that ‘monetarily’ India has become highly unstable. Monetary instability is implied by the double-digit inflation, which has raged for seven years now.  Therefore, it was no surprise that in his first statement as Governor, Rajan said that the RBI would go back to the basics. It would focus on preserving domestic monetary stability and the purchasing power of the Indian currency. Indeed, Rajan drew attention to the RBI’s founding charter, which says that the role of the central bank is to regulate the issue of bank notes, preserve monetary stability and generally operate the currency and credit system to the country’s advantage.

Barring bank notes management, the RBI has not covered itself with glory on the other responsibilities.  The proximate cause of the serious economic downturn of the past seven years is that inflation has become entrenched. Therefore, zero marks on monetary stability. As for operating the credit system to the country’s advantage, there is not much to be proud here also. How can we be when nearly 10 per cent of the banking sector’s credit assets are of doubtful quality (sharply higher than earlier period averages) and also importantly, nearly 90 per cent of India’s  SME businesses have no credit links at all with the formal banking system?

Will Rajan succeed? Well, his long-term success depends on whether the political establishment fully embraces the basic objectives set by the RBI’s charter.

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