Saturday, June 18, 2016

Rexit - Exit of Raghuram Rajan

Source - IMF / Wikipedia
Seems like Modi Government was not ready to renew Raghuram Rajan's term at RBI helm and then Rajan threw the towel. In a sense, the round goes to Subramanian Swamy; Rajan's rabid critic.

When appointed, I had a mixed feeling about Rajan. I still think Rajan's supply side inclination in American Political Economy has been misplaced. I am with the narrative of Bernanke-Krugman-Lawrence Summers with heavy Keynesian dose. Even though I recognize the danger of 'being exposed with no arrow in the quiver' when Fed rates are at near zero for a prolonged period or negative rates in Europe and Japan hardly bringing the growth; I read America's Economic recovery, however halting, during Obama years as a result of fiscal stimulation policy dose during 2009 & 2010 when Democrats controlled both chambers of Congress and subsequent Monetary policy pioneered by Bernanke in coordination with Lawrence Summers in Administration; continued till date by Janet Yellen. Raghuram Rajan sides in this debate with likes of Wall Street Journal, likes of  'tax cuts for rich' trickle down gang which hardly has much credibility when one considers facts.

But in the Indian context I feel Raghuram Rajan was applying the right medicine. It is obvious that Indian Economy is no way similar to American Economy. Fundamentally, the causation of 'interest rates to private credit / business expansion' is completely dwarfed by the structural rigidities of Indian Economy. To start with, Indian State plays enormous 'direct role' in economy via huge Public Sector where politics of pampered Labor trumps relation to output generated by these giant state corporations. Meanwhile very large private employment in India comes from 'informal sector' which is neither regulated nor participates in tax collection. In most cases these informal sectors are deprived of an access to Capital making the relationship between 'interest rates to employment generation' a moot point. Endemic, deeply entrenched corruption greatly siphons of tax payers money making State intervention of fiscal stimulus ineffective. Archaic legal system makes timely and effective enforcement of laws and private property protection difficult, hindering smoother private transactions. Economic statistics collected by Indian Government still has a long way to go before it provides accurate and timely snapshots of Indian Economy to policy makers. Given all these structural weaknesses of Indian Economy and Economic Policy Making; the natural tendency of India Economy is shortage of supply. With young and huge population, India does not have the problem of demand. It is the 'supply disruptions' which create problems in Indian Economy. Given this background, I thought Rajan's emphasis on 'controlling inflation' was the right choice. Indian Economy, due to its deviations from a free market economy, has a natural tendency towards Inflation. Fighting Inflation and bringing Price Stability are the keys for Indian Economy. This is especially true since with globalization and reduction in License Raj; Global Capital is very much interested in growing Indian market whereas competitive electoral politics limits structural reforms.

For Swamy to argue that Rajan should reduce interest rates to generate employment, is to ignore the 'weak relationship of interest rates to employment generation' in India. More importantly it is to ignore the persistent and constant danger of 'inflation' in Indian Economy. I thought that is where Raghuram Rajan was bringing the discipline, the basics of Paul Volcker Fed. With that discipline gone, danger of 'inflation' will be back. What is surprising is, for the fetish of 'low interest rates to generate employment'; Swamy and Rajan critics have exposed Modi's BJP government to one of the most potent political issues - price rise. Umpteen times in Indian Politics, rising prices have contributed to the fall of the government. With Rajan gone, Modi's BJP is exposed to that vulnerability. 

Fed's dual mandate of 'full employment and price stability' in some sense does not translate as RBI's mandate. For Indian Economy, 'inflation control' needs to be the sole preoccupation of the central bank. Rajan was doing that. May be for his detractors, the economic argument was not important; but rather perceived transgressions of Rajan in political arena when he raised concerns about 'lack of tolerance in Indian political system'. If that is what peeved his detractors, it is a concern. It is concerning because it seems like Indian polity is deteriorating when it comes to 'tolerance' and ruling BJP is in no mood to tolerate anyone who does not toe their party line. Either ways, Rajan departure is not a positive development. Saving grace is India is a big country and it has at her disposal a large pool of qualified folks to choose from. The only thing needed is the political will to let a RBI Governor run the monetary policy competently.

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