What is India's Monetary Policy
The country's most prominent economist resigns
Raghuram Rajan restored confidence in India's central bank in just three years. The government must be careful not to gamble this away.
Even in India's culture of debate, which is characterized by emotion and spectacle, economists usually play a sober, commenting role away from the limelight. It is therefore rather unusual when the country's most widely read business paper in the past argued about the central bank chief's sex appeal and the largest manufacturer of dairy products had his mascot call on him to accept a second term in office. Of course, the advertising stunt of the milk cooperative Amul was of no use: Raghuram Rajan handed over the office to his previous deputy Urjit Patel on Sunday, as announced.
At the end of Rajan's three-year term in office, more sober observers refer more to the track record of the former chief economist of the International Monetary Fund (IMF) than to his unusually prominent role in public life. Rajan took office at the height of the rupee crisis, when the Indian currency suffered its sharpest fall in value - and the central bank its greatest loss of confidence - since the insolvency of 1991, which was narrowly averted. Partly against considerable political pressure, Rajan stuck to the course of strict inflation control. In this way, and thanks to the collapse in prices on the raw material markets, inflation was reduced from double-digit values in 2013 to an average of 5–6%. At the same time, the foreign currency reserves were increased noticeably.
To secure what has been achieved, Rajan has put Indian monetary policy on a new footing. The central bank (Reserve Bank of India, RBI) was given a binding inflation target (4% with a tolerance of +/- 2%), and a new committee made up of representatives from RBI and the government determined the key interest rate. Failure to meet the inflation target must be justified in writing. What looks like a stronger say for politicians is ultimately a safeguard against the frequent pressure attempts in the past, since the government is now also responsible for monetary policy. Contrary to many fears, the leadership of Prime Minister Modi seems to support this course after Rajan as well. With the appointment of Patel, one of the architects of these reforms will head the RBI, so that its inflationary course should not change. This was received with relief, especially by the international investors who are central to India's modernization and for whom Rajan was the guarantor of a transparent and reliable monetary policy. The feared extensive capital outflow has not yet occurred.
The development of the second major reform project is more open. Rajan, who recognized the dangers in America's mortgage market early on, pushed for a cleanup of Indian banks' balance sheets. A review by the RBI in 2015 showed that the previous 4 trillion. R estimated bad loans even down to 6 trillion. R (CHF 88 billion). The association of the political elite with the country's major corporations led to inadequate lending controls, especially at the state banks. This, like the lack of effective bankruptcy law, also hinders the collection of outstanding debts. The funds tied up in this way are no longer available to the credit system, which in turn is one of the reasons for the limited ability of smaller economic actors to take out loans. The long-term goal of RBI is therefore to create alternative financing channels. For example, the hitherto underdeveloped market for corporate bonds is to be promoted.
Only a "half Indian"
During the banking reform, Rajan came into conflict with circles from the political and economic establishment even more than he did with inflationary policy, since he implicitly pointed to decades of nepotism and a lack of transparency. This and his comments beyond monetary policy, such as the criticism of increasing intolerance in Indian society or the characterization of Indian economic growth, the fastest in a large economy worldwide, with the bon mot of the one-eyed among the blind, earned him violent hostility. The ideological agitator of the right-wing conservative ruling party BJP, Subramanian Swamy, launched a regular campaign against Rajan and described him as “only half an Indian in spirit”. Modi later distanced himself from Swamy's statement, but Rajan let it be known that the lack of support in the government had tipped the scales not to seek a second term.
Such open conflicts are unlikely to arise with Rajan's successor, Urjit Patel is considered cautious and extremely loyal to Prime Minister Modi. This does not make the economist, whose technical competence is not in question, a bad head of the central bank. The RBI does not necessarily need a star at its top. What the monetary authority needs, however, in order to maintain the trust that Rajan has regained is institutional independence and a clear commitment by the government to respect this, even in the event of dissent. The opaque consideration of particular interests up to the highest levels is one of the reasons that India still ranks 130th on the World Bank's Ease of Doing Business list. After Rajan's departure, the government must again provide evidence that it is serious about the independence of the RBI.
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