Interview with Raghuram Rajan, Chief Economic Adviser

Chief Economic Adviser Raghuram Rajan took over at a time when there was a change in the Finance Ministry at the top with Mr. P. Chidambaram returning to North Block. The UPA government has now switched to “reforms” mode. In conversation with Ashok Dasgupta, Dr. Rajan explained some of the measures that have been initiated. Excerpts:

Dr. Rajan, you took over as Chief Economic Adviser almost along with Mr. P. Chidambaram returning as Finance Minister. Were you not surprised by the change in the government’s policy stance?

Well, I don’t think any of the steps the government has taken were not steps that were being debated. I think the need to increase fuel prices was clear. FDI at various fronts was clearly something the government had tried before. I think the public surprise has been that the government went so far in putting all these things together and, of course, I presume the answer, the reason is the political equation changed somewhat so that the government saw space for it and knew it had to be done. I am not privy to what particular equation changed; all I can say is I think the set of reforms has been good.

But from a state of inertia, the sudden push to reforms…

I would say more generally, one of the things in a democracy is that difficult times create this space for reforms. You can see that again and again in the European Union in the euro area. When times get tough, somehow they find the political space to do more and they surprise the markets. I think the people who think that democracies go in a straight line and the paralysis of stagnation is permanent ignore the fact that ultimately, politicians have to respond to the people, to the electorate and sometimes space is created. So that is the general academics of equation but what specifically changed this time I can’t guess. I think there is no secret that Mr. Chidambaram is a Finance Minister who certainly made some changes and also pushed hard but there are other factors also at play.

Did the threat of downgrading the sovereign rating play a role?

I am not sure how much that necessarily played a part. Clearly nobody wants the rating down and we need to do our best to stay investment grade because there are some ramifications to downgrading. But I think the moves are not taken primarily with that in mind. I mean they are necessary for the logic of the economy to get out of a situation where deficit spirals create problems for your external front because when you have large external debt we have to borrow money. For every subsided rupee you have spent, you have to borrow it from outside. That is not a pleasant situation. Then, of course, there is an effect of inflation, of higher government deficit, for more demand and eventually over the long run, higher inflation. We just had a presentation and there is a general sense that the high subsidy can’t go on. Anything that is unsustainable will stop.

Is it safe to assume that minority governments are faster on reforms?

I don’t think you need to draw that equation. I mean Indian history with the Narasimha Rao government might suggest that. But at the same time you can see episodes where minority governments were not particularly functional either. So I don’t think you need to draw that conclusion. What I do think is that the current team in the Finance Ministry as well as the PMO are very eager to continue this process so as to bring back the rates of growth.

The debate over investment through FDI and FII inflow. Right now it is FII inflow…

I think what we need to do is to establish the fact that we are a healthy economy so that we are seen more as a haven rather than something to run from. So we need to have better policies; if we look like a good emerging market rather than the weakest BRIC nation, I think we will benefit. So you know every country has its problems. Brazil has problems with credit. Chinese growth has been coming down. And there are concerns that the investment model they had is problematic. So in this environment what is it that we can do enough to look different; to look attractive? Every investor is looking for high rates of growth. If we show that we are creating a pathway to that, then maybe some of the FII hot money will actually become cold money. That should be an objective and of course in the longer run it has to be substantiated by FDI flow and adequate reserve.

You also talked about inflation, people seem to be getting richer and consuming more…

We have to be careful about this. There are so many segments of Indian society. Clearly the people who are destitute never had any income or are made much worse off when prices go up. In fact, nobody is better off when prices rise. My intent [in saying that inflation must be fought by producing high-end food products such as milk, eggs and meat rather than cereals] was to say that if you look at rural wages, they have been growing much faster than urban wages over the last three years. And it is going up in real terms. With inflation growing now there has been an impact on rural consumption. And part of rural consumption is food. They are moving up from cereals to higher order food — pulses, vegetables. That is a good thing. The not so good thing is that the supply has been kept fixed. You will think farmers should have been given incentives to produce... but sometimes the supply chain network is not in place which does not allow farmers to access the market. So building in a supply chain network is an important factor we need to focus on. I think [it is important to recognise] that the food inflation reflects the greater purchasing power in some quarters, not in all. At the same time, it creates hardship for others. We need to bring it down. So my whole point was that we need to bring down food inflation. But the way we have to do it is probably by augmenting supply, because squaring demand is not going to be feasible. Demand is natural as people are growing richer and buying high order food. That is harder to stop.

But won’t the hike in diesel prices fuel inflation?

Only in the short term. In the long term, inflation will taper down. In the medium term, that is, within two to three years, I expect the economy to return to the high growth track of about eight to nine per cent. Of course, it does call for more reforms, reduction in subsidy through a targeted approach.