Opinion » Comment

Updated: August 9, 2013 04:20 IST

Banking on more than luck

M. K. Venu
Comment (7)   ·   print   ·   T  T  
Raghuram Rajan.
Illustration: Rajesh
Raghuram Rajan.

Raghuram Rajan needs to think fast and creatively as he prepares to lead the RBI and its efforts to stabilise the rupee

One of India’s most astute Central bankers, Y.V. Reddy, once said that when faced with a very complex macroeconomic and political environment, what really matters is your intuitive capacity to take the right decision based on experience and knowledge. Some of these intuitive calls may even go against the grain of what well-established technical templates of economics might dictate. After all, “rational policy” has been conspicuous by its absence since the world economy went into a slump in 2008. Every conventional rule of economics has been turned on its head over the past five years.

Indeed, the big challenge for Raghuram Govind Rajan, who will be among the youngest governors of the Reserve Bank of India when he assumes charge on September 4, will be to hone his intuitive ability to do the right thing in the crisis-like situation that has engulfed the economy.


Mr. Rajan is credited with having displayed a sharp, contrarian insight in 2005, in the middle of the global economic boom, at a function held in honour of the then awe-inspiring Federal Reserve Chairman, Alan Greenspan. In the midst of the Greenspan-led liquidity and credit boom in America, Mr. Rajan had raised the question of whether banks will be able to provide adequate liquidity to the financial markets in the event of large-scale credit defaults. He had also asked whether in such an eventuality “how financial positions would be unwound and losses allocated in a manner that the consequences for the real economy [would be] minimized?” This question remains valid today as large-scale socialisation of losses continues to weigh down sovereign balance sheets, causing social unrest across the developed world, especially Europe. While losses have been socialised, private bankers are fully back in business.

Mr. Rajan, a Professor of Finance at the Booth School of Business, University of Chicago, came as an honorary economic adviser to Prime Minister Manmohan Singh in early 2008. In that year itself, he headed a 13-member committee which recommended far-reaching reform of the financial markets as well as the banking and regulatory system. Some of the big ideas generated by this committee, including fuller capital account convertibility, had lost intellectual support after the 2008 global financial meltdown when reigning market theologies underwent a big change. The role of central banks also altered fundamentally.

For instance, the Rajan Committee in mid-2008 had recommended that the RBI should confine itself to formal inflation rate targeting for the economy as some western central banks do. The job of regulating banks should be done by a different authority. However, the RBI resisted this idea and D. Subbarao publicly declared that the global consensus after the 2008 financial crisis was that central banks must pursue multiple objectives, including overseeing financial stability. Mr. Subbarao had implied that in Indian conditions, the narrow mandate of inflation targeting would not work. The RBI indeed went on to pursue multiple objectives. The governor was supported by reputed former RBI Governors like Bimal Jalan, Y.V. Reddy and even C. Rangarajan in this argument. This debate remains inconclusive. Mr. Subbarao’s stance was seen by critics, including members of the Rajan Committee, as the RBI’s reluctance to give up its turf.

However, it will be interesting to see how Raghuram Rajan, as RBI governor, views his own recommendations of the past. He cannot bring about any radical change in the bank’s functioning without taking the RBI bureaucracy, which seems quite formidable, into confidence. The RBI has institutional credibility flowing from its history and is known to have fought successful intellectual battles in recent times to preserve its core mandate.

For instance, Pranab Mukherjee as finance minister created an overarching financial stability body called the Financial Stability and Development Council (FSDC). This body, headed by the finance minister, was meant to supervise all regulators, including the RBI. The RBI resisted this idea vigorously and managed to get Mr. Mukherjee to considerably dilute the idea. As a result, the FSDC exists largely on paper today.

Interestingly, the idea to create this body came from the Raghuram Rajan Committee. Will Mr. Rajan, as RBI governor, try to breathe new life into FSDC? If he were to pursue some of the bigger ideas he has espoused personally and through formal committees, he would end up whittling down the RBI’s current mandate.

Task ahead

In any case, in the immediate short to medium term, Mr. Rajan will be fully preoccupied in the firefighting exercise to stabilise the currency market which is the single biggest challenge for the central bank and the United Progressive Alliance (UPA) government. The rupee’s value has gone down from Rs.45 to a dollar in May 2011 to Rs.60 plus today. In just over two years, the rupee has lost over 30 per cent of its value. The rupee’s value crossed the first psychological threshold of Rs.50 in 2011 and stayed mostly above Rs.50 in 2012. This year, it breached the second psychological barrier of Rs.60 and, in spite of all efforts by the government and RBI in recent weeks, the downward pressure on the currency continues.

The RBI today is caught between a rock and a hard place. Economic growth has collapsed and the central bank wants to ease interest rates to boost the economy. If the RBI eases interest rates, it is feared the rupee may weaken further causing a spiral effect. Currently, the RBI cannot address growth and its sole focus is on curbing the rupee’s volatility and letting it come back to its fair value. C. Rangarajan, Chairman of the Economic Advisory Council to the Prime Minister, reckons the appropriate value of the rupee based on the commonly accepted 6 country or 36 country trade-weighted basket is about Rs.59 to a dollar. Going by this metric, the rupee is clearly undervalued. The RBI’s challenge is to see that the rupee does not slide further to Rs.65 to a dollar, which many analysts predict.


The government needs to pay about $172 billion of short-term debt within one year, by March 2014. Then there is a current account deficit of about $80 billion which needs to be met with capital inflows. It is estimated that Indian corporates have taken foreign loans of over $200 billion and over 50 per cent of this dollar credit exposure is unhedged. This means these companies have already suffered an extra $30 billion loss in their books because of 30 per cent rupee depreciation in two years. It must be remembered that the high corporate foreign currency loan defaults had primarily caused the East Asian currency crisis and capital flight in 1997.

Mr. Rajan will also have to grapple with the sharply deteriorating loan portfolio of banks. Since 2008, Indian banks have restructured loans of business houses which, if strictly accounted for, may take the non-performing loans to about eight per cent to 10 per cent of the total credit outstanding. This is another time bomb ticking. A large number of influential businesses have used their political clout to postpone repayment of loans even as their extravagant, personal lifestyles have not changed. Mr. Rajan may have to draw some ideas from his first book, co-authored with Luigi Zingales, titled Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity in dealing with future loan defaults by big corporates. All in all, he is walking into rather rough weather.

More In: Comment | Opinion

All Indian,

Although it is very complex issue. The simple line of action to
enhance rupee value and to address financial crises is :
1)Long Term Goal : India should plan for target INR 1 = 1 USD.
You may say it is NOT possible but for India it is not difficult at
More focus on Development of SME Manufacturing and services which we
import from the world and Development of Agro based Industry (Value
added products)to export the world class quality processed food.
2)Short Term Goal:a)Establish Committee to recheck on the amount which
is transferred and paid towards technology transfer.Quality of
technology and value paid for by India b)Redefine on payment terms and
conditions towards technology transfer and link payment to minimum
export guarantee. c)Compulsory Maximum possible bonding of Ethyl
Alcohol with all petroleum products to reduce pressure on Oil
imports.d)Stop allowing people of India to invest into Gold to reduce
Gold import.e)Manufactucturing Import substitutes.

from:  Sanjay B Renge
Posted on: Aug 10, 2013 at 20:29 IST

Please let me make a correction to my earlier post. The last sentence should read, for better clarity, as follows: "A
currency can appreciate infinitely, but can depreciate, at most, only
100%. By your calculation, it can depreciate more than 100%! Beyond
100%, the currency has no intrinsic value and, therefore, fetches no

from:  Devraj Sambasivan
Posted on: Aug 9, 2013 at 19:28 IST

C: Single regulator for the financial sector –This
was the main song of the financial services players in the last 35
years –selling of all services under one roof. Investment banks wanted
to be commercial banks and insurers wanted to be bankers too and vice
versa. Catch phrases like allfinanz and bancassurance as alternative
channels were popular. The recent meltdown in the wetern financial
sector has revealed the wisdom of each concentrating on its core
operations. Thus, back to square one. Insurnce companies want bankmen
to sell products of half a dozen insurers , a case of lazy marketing.
Also resulting in the sdilution of service towards banks’ own
customers. On the one hand govt. wants to increase the foreign equity
limit to 49% but on the other they encourage t systems where private
insurers are enabled to limit their marketing through creamy layers of
bank customers and not make any serious attempt to reach the interior.
What an anachronism this! Thus far

from:  s subramanyan
Posted on: Aug 9, 2013 at 15:29 IST

(A) Fine word 'luck' in the title, which cuts both ways - helping
foresee the 2007/8 crisis but failing the idea of 'fragmented'
regulation. The wheel has turned full circle. In the U.K., FSA is
history and prudential supervision of banks is back at BoE, as PRA.
(B) Please stop bothering about the 'psychological threshold, barrier'
of the rupee! Which psychiatrist decides them? Which other country
flaunts them for its currency? Anyway, like earlier breaches of
‘barriers', Rs. 40/-, 50/- etc., we simply adjust to them, don't we?
(C) The rupee doesn't 'go down' or 'cross' any value; the rupee is,
forever, 100 paise! What changes is the rupee's buying power - number
of cents here. A rupee buying 2.2222 cents in 2011 now buys only
1.6393 cents. The rupee's depreciation is from 2.2222 to 1.6393 =
26.22%, NOT 'over 30%'. Over 30% is the appreciation of the dollar. A
currency can appreciate infinitely, but depreciate at most 100%; by
your calculation, it can! It has, already, since 1947!

from:  Devraj Sambasivan
Posted on: Aug 9, 2013 at 11:56 IST

>Some areas needing Mr.Rajan’s special attention:
A:Indian Posts with vast network doing full banking functions seems an
enticing proposition especially in the context of ‘financial
inclusion’. Do we want a bank to be set up at a cost of infusing
public money of the order of Rs. 500 crores as its capital? See the
choices of places it is itching to move in,viz.Chennai city etc. and
not some distant areas needing financial penetration. Already the
banking sector has problems relating to NPAs, human resources and
unemployability of the candidates available. In IP’s case this will be
even more problematical. (In a post office in Navi Mumbai I noticed
this board: “Strategies for opening a postg office deposit
account”(!?) If we have to search for strategies for even opening an
account imagine the hassles in operating it daily by rural folks
?)Further, this banking endeavour will retard IP’s core functions
where it has left much to be desired. So on an overall and unbiased appreciation it would
be wiser for the authorities to leave out IP from banking aspirants’
B: Consolidation of public sector banks.
C: Single regulator for the financial sector

Posted on: Aug 9, 2013 at 10:53 IST

"An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today."- Laurence J. Peter
Making economic policies for such a huge economy isn't a easy job. The problem with economist is that when they use formulas and maths to define things they generally assume some things. I am not saying that Math is bad but sometimes it leads to oversimplification or worse miss-judgement of the situation. That is what is happening in Indian economy. When they use Math to solve economic problem economy started to look like science as physics. But economy isn't a science. You can't quantify many things most of the time.
I hope the new RBI Governor stop interfering with the exchange rate and let the market decide it. Government should be more concern with it's duty like controlling inflation, minimizing corruption etc. Indian economy is a mixed economy combining features of capitalism and socialism which further more confusing.

from:  Sasanka Medhi
Posted on: Aug 9, 2013 at 07:15 IST

Excellent article which describes the tougher role ahead for Mr. Rajan and every one in the country would want him to come out flying colors. To do this, he might seriously need all the support from the top officials of RBI and Indian Bureaucrats. I wish him all the very best to him in all of his future endeavours (especially the aforementioned one) and hope he could bring back our currency(Rs) to the optimal balance towards the world's currency ($).

from:  jrjegon
Posted on: Aug 9, 2013 at 04:21 IST
Show all comments
This article is closed for comments.
Please Email the Editor

The Government of India has taken a serious view of the concentration of Pakistani troops along the border between India and East Pakistan.

Read more »



Recent Article in Comment


An education in acronyms

Amid a plethora of cleverly named new schemes and tech-fixes, the HRD Ministry is busy tinkering with bureaucratic processes. »