When Raghuram Rajan demits office in the first week of September after serving as Governor of the Reserve Bank of India (RBI) for three long years, the anti-BJP camp in India will be looking forward to Rajan’s tell-all book. If he does not come out with such a potential bestseller, as he himself has said, conclusion will be that Prime Minister Narendra Modi has bought peace with the financial wizard. This of course will not stop furtive comments on the “economic mismanagement of the Narendra Modi government”. Predictably so, since the outgoing Governor himself seems to be keen on hinting that. Rajan’s comment in a TV interview is a pointer. When asked of his views on PM Modi, Rajan reportedly said that he would not since it would create unwarranted controversy. Clearly, the allusion illustrates Rajan’s love for controversy.
From the series of interviews that Raghuram Rajan gave after the third bi-monthly monetary policy announcement on 9 August, it was evident that Rajan would have loved an extension as RBI Governor. Though he had announced with much bravado that he would like to go back to his first love, academics, the evident heartburns betray his frustration. It seems Rajan thought himself to be indispensable of sorts and attempted to exert pressure on the government. There was no mortal hurry for him to announce his departure on the conclusion of his three-year term. He could have made it public 28 days before demitting office, on 9 August, after placing the bi-monthly policy. Instead, he chose to write to the RBI staff on 18 June, five days before the crucial Brexit vote, that he would not seek a second term.
There are several firsts in Rajan’s dramatic announcement. Never before in the long history of RBI did a Governor announce his departure through a letter to the RBI staff. Rajan acted melodramatically and his step was not in good taste. But he knew that the media dislike for the Central government is so strong that the government would be criticised and his indecent behaviour would not be raised at all. So Subramanian Swamy was made the fall guy. In fact he is still held responsible for Rajan’s departure from the RBI job.
When Rajan expressed his desire to leave in a well publicised and unprecedented public letter he said, “I am an academic and I have always made it clear that my ultimate home is in the realm of ideas. The approaching end of my three-year term, and of my leave at the University of Chicago, was therefore a good time to reflect on how much we had accomplished... While I was open to seeing these developments through, on due reflection, and after consultation with the government, I want to share with you that I will be returning to academia when my term as Governor ends on 4 September 2016. I will, of course, always be available to serve my country when needed.” This was on 18 June, five days before the crucial vote of Britain’s continuation in EU was to go for vote. Central banks, all over the world, were concerned of the possible impact of Britain leaving EU. This was when Rajan chose to announce his intent. Was it necessary for him to do so? Was the timing carefully planned so that the government found it difficult to meet the possible challenges in the forex market? Doubts arise from the tweet of former Finance Secretary Arvind Mayaram: “Raghuram Rajan’s decision not to seek second term would be very costly for the eco(nomy). Not a good omen.” Is there any reason to guess that Raghuram Rajan was innocent of the possible implication? If not, does it not prove the point that Swamy raised, that Rajan was “mentally not fully Indian” and that he was wrecking the economy? Nobody questioned Rajan on this yet.
Those who had cared to take a look at Rajan’s monetary policy have generally found the measures sound. Some analysts applied the Taylor rule and concluded that Rajan was prudent and as of now RBI policy rate is just marginally lower than the rate obtained after applying Taylor’s calculation. Without going into the technical argument of blind faith in John Taylor’s formula, if one looks at the divergence of rates — calculated as per Taylor and RBI Repo rate — one will see that during a large part of the two-year of Modi government, Repo rate was higher than the Taylor rate, clearly highlighting the fact that RBI should have reduced rate. That Rajan did not is yet another proof that Swamy had a point in doubting Rajan’s intention.
Two important factors were also brushed aside by the Rajan-led RBI. Rajan shifted his inflation target base to consumer price inflation, CPI. A large part, more than half — as an analysis by State Bank of India’s chief economist Soumya K. Ghosh pointed out — of CPI is food items. Interest rates have no effect on food prices, the sector being outside the organised sector. More important, food prices depend on the vagaries of weather, monsoon, drought, flood, etc. Should RBI then base its interest rate policy on an index that is mostly externally determined and not impacted by interest rate? Nobody cared to ask Rajan this question, though the largest commercial bank of India flagged the issue.
The second point that was never raised is the trade-off between inflation and job creation. In Taylor’s equation, the target nominal interest rate (Repo in our case) is determined by the current rate of inflation, desired rate of inflation, current rate of GDP growth, potential rate of GDP growth and assumed equilibrium real interest rate. Elementary sense says that the weight for production differential will be more than the weight of inflation differential in a developing economy like India. In an advanced economy like the US, Taylor revised his equation with a lower weight for productivity than inflation. The weight should depend on the scale of full employment in an economy. Did Rajan, the economist, apply this elementary thought while claiming to have applied the Taylor formula for interest rate fixing?
Since Rajan was viewed as a great economist by virtue of his prediction of the 2008 crisis in advance, nobody dared to seek the economic logic from him. That the crisis of 2008 will be there was not in doubt, the question was when and how much. More important, if prediction is viewed as an expertise to assume the charge of RBI, then this writer, who predicted a Narendra Modi victory in 2014, should have been made India’s Election Commissioner. Rajan’s ability does not rest on that prediction, whatever the pliable media might say.
Rajan’s importance lies in his guts to challenge the established thoughts, like he did in an article this year. Rajan felt that for fixing interest rates, Central banks of developed economies must consult the large developing economies like India, given the importance of these economies in global trade and production. Rajan is right; he is an academic who brings out of box thinking to the fore. Sadly, Rajan played his RBI card too early. Now he may write any number of papers supporting his suggestion on changing the global financial order, but an academic will receive little or no attention amongst the practicing Central bankers. Had Rajan remained in RBI, he would have gained from the stature of India’s Prime Minister Narendra Modi. He could even have Modi as his ally in pushing his point. Now his point will remain a lost cause to be debated in the lower echelons of the academic circuit. No wonder Rajan is feeling sad now.
What is more, the manner of his resignation, an effort to fix India at the altar of his bloated ego and resigning just before Brexit, will be remembered. This is certain to act as a blot in his career. Rajan may find it difficult to win any responsible assignment as long as people remember this intransigence.
Raghuram Rajan is paying the price for thinking that he is indispensable.