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Rexit in India

Rexit in India

Financial markets jitters over Rajan rumpus

by Meghnad Desai

Mon 20 Jun 2016

Raghuram Rajan, governor of the Reserve Bank of India since 2013, has decided to return in September to Chicago’s Booth Business School, where he is on professorial leave. This was not a total surprise, but the weekend news again raises questions about the Reserve Bank’s independence.

Rajan has taken the view after talking to the government that he does not have the administration’s unequivocal support. He has decided not to wait until he is refused a second term after his three-year mandate runs out in three months. This is ‘Rexit' – India’s equivalent of ‘Brexit’, Britain leaving the European Union.

The episode dents India's reputation for maintaining robust institutions free of political interference. The government’s abandonment of a tough anti-inflation central banker for reasons of party politics will not go down well on financial markets. As foreign investors decide their stance on India, the rupee is likely to come under pressure. This seems another case – seen already in the retrospective taxation wrangle over UK telecommunications business Vodafone – where the government places a higher priority on national sovereignty than economic prudence.

As the UK EU referendum on 23 June nears, markets are already jittery about Brexit. Another rumpus is unwelcome.

Corporate leaders such as Narayan Murty of technology company Infosys and Kiran Mazumdar-Shaw of biopharmaceutical group Biocon have expressed dismay at the loss of a brilliant economist. Rajan's credentials are not in doubt. As chief economist at the International Monetary Fund in 2003-06, he famously spelled out the danger of a financial breakdown in 2005 at the Kansas City Federal Reserve Bank’s annual Jackson Hole conference.

Manmohan Singh, Congress prime minister in 2004-14, asked Rajan to examine issues of financial stability as a consultant and then as chief economic adviser to the finance ministry. Then came promotion to the central bank. The youngest-ever RBI governor will now break with the normal practice of serving two three-year terms.

Rajan's governorship has been dogged by controversy. When the Bharatiya Janata party-National Democratic Alliance government came to power in 2014 under Prime Minister Narendra Modi, Rajan took a tough stance on inflation and did not immediately cut interest rates as favoured by BJP economic experts led by Subramanian Swamy, a Harvard Ph.D. of 1960s vintage.

Swamy, a maverick yet influential politician who co-authored articles early on with Paul Samuelson, the US Nobel economics prize-winner, gave up a brilliant academic career to enter politics in opposition to the establishment Congress party.

Even before Modi’s 2014 election Swamy argued that Rajan was pursuing a growth-inhibiting deflationary policy that was ruinous for small and medium-sized businesses. The Modi cabinet showed some sympathy for this view, even though neither Modi himself nor Finance Minister Arun Jaitley overtly supported it.

Rajan has established inflation-targeting under a monetary policy committee. Over the last two years, the policy interest rate has fallen to 6.5% in six 25 basis-point steps. Additionally, Rajan has raised pressure on public sector banks to tackle non-performing assets and clean up balance sheets.

Swamy’s anti-Rajan sniping has continued, centring on well-broadcast doubts about whether Rajan, as a US green card holder renewed through annual US visits, shows sufficient devotion to India. It is a peculiarity of Indian politics that such attacks are taken seriously and debated in the media.

Swamy has spoken against a second Rajan term on the grounds that his appointment during Congress rule places in doubt his BJP loyalty. The finance minister and the prime minister failed to give the governor public support, saying merely that renewing his contract would not be debated publicly.

Regarding a successor, there has been speculation about Arvind Subramaniam, the government's chief economic adviser, Subir Gokarn, a former RBI deputy governor, and Urjit Patel, a current deputy governor. After Rajan's experience, the government is unlikely to turn again to a glittering economist from outside the country. India's economic policy will be the poorer.

Lord (Meghnad) Desai is Emeritus Professor of Economics at the London School of Economics and Political Science and Chairman of the OMFIF Advisory Board. He serves as the founder chairman of the Meghnad Desai Academy of Economics in Mumbai.

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