1) ON THE IMPACT OF THE US FEDERAL RESERVE’S EXIT POLICY
From Rajan’s Andrew Crockett Memorial Lecture delivered at the Bank for International Settlements in June 2013:
“Having experienced the side-effects of unconventional monetary policies on “entry”, many now worry about exit from those policies. The problem is that while “entry” may take a long time as the central bank needs to build credibility about its future policies to have effect, “exit” may not require central bank credibility, may be anticipated, and its consequences brought forward by the market. Asset prices are unlikely to remain stable if the key intent of entry was to move asset prices from equilibrium.”
2) ON MONETARY POLICY AND ITS OBJECTIVES
From ‘Next generation financial reforms for India’, in the magazine Finance & Development, September 2008:
“What are the options for monetary policy, especially now that the demands on it are growing as the economy becomes more open and exposed to a wider array of domestic and external shocks? The Reserve Bank of India (RBI), India’s central bank, has done a good job of managing the multiple mandates foisted upon it—keeping inflation under reasonable control, managing some of the pressures on the exchange rate, and coping with capital inflows—all against the background of strong growth. But there is a risk that this high-wire act has reached its limits. The recent volatility in the rupee has revived calls for RBI to more actively manage the exchange rate, which is becoming increasingly difficult as the capital account becomes more open. Sustained intervention in the foreign exchange market can also create unrealistic expectations about RBI’s ability to manage multiple objectives with one instrument.”
“Focusing on a single objective—low and stable inflation—is ultimately the best way that monetary policy can promote macroeconomic and financial stability. This does not mean sacrificing or ignoring growth. Indeed, well-anchored inflationary expectations may well be the best tonic that monetary policy can provide for growth. Contrary to what some commentators seem to believe, there is no long-run trade-off between growth and inflation, and for monetary policy to try and engineer a short-run trade-off can be dangerous. In short, the inflation objective would in fact make monetary policy more effective and strengthen RBI’s hands rather than pinning them down.”
“The consensus that maintaining low inflation is the central bank’s job, and its only job, did not develop overnight in those countries, it took time. It is our hope that this consensus will develop in India also.”
From ‘Why an inflation objective?’ by Raghuram Rajan and Eswar Prasad, written after the submission of the report of the Committee on Financial Sector Reforms in 2008, headed by Raghuram Rajan:
“Our suggestion is to move towards a single objective for monetary policy—low and stable inflation. But this is not about sacrificing growth or other important objectives at the altar of low inflation. There is no long-run trade-off between growth and inflation, and for monetary policy to try and engineer a short-run trade-off can be dangerous. Well anchored inflation expectations constitute the best tonic that monetary policy can provide for growth. The evidence also shows that low and stable inflation reduces macroeconomic volatility and is good for financial stability. Even exchange rate volatility is lower in inflation-targeting economies.”
3) ON INTEREST RATES
From the paper “Illiquid Banks, Financial Stability, and Interest Rate policy”, April 2011:
“Rather than relying on ex ante regulation of banks, central banks may want to improve financial sector incentives to curtail promises of liquidity by raising interest rates in normal times more than strictly warranted by market conditions—central banks may need an additional form of credibility than just being averse to inflation.”
From “Money Magic”, an article published by Project Syndicate in June 2011:
“More than any other policy action, monetary policy suffers from the sense that there is a free lunch to be had. Yet the interest rate is a price for the savings that are transferred to spenders. To the extent that the Fed manages to push this price down (and some economists will dispute its ability to push any meaningful interest rate down), it taxes the producers of savings and subsidizes the spenders of savings.”
4) ON THE EXCHANGE RATE
From the headline of an article published in ‘Foreign Affairs’, March/April 2011:
“Currencies aren’t the problem”
“Fix Domestic Policy, Not Exchange Rates”
From ‘Exchange Rate Policy’ by Raghuram Rajan and Eswar Prasad, written after the submission of the report of the Committee on Financial Sector Reforms in 2008, headed by Raghuram Rajan:
“Monetary policy would be more effective if it was focused on a single objective—low and stable inflation. This would imply minimal management of the exchange rate by RBI, except perhaps to smooth extreme volatility, including preventing significant departures from equilibrium.”
From ‘The next generation of reforms in India’—speech at a function to release a book of essays in honour of Manmohan Singh in April 2012:
“The gap between our spending and our saving is making us dependent on short-term foreign inflows to a dangerously high extent, at a time that the international investor is increasingly sceptical about the India story. The depreciating rupee is the first sign of an unstable economy, rising long-term interest rates could be the second.”
5) ON BANKING IN INDIA
From ‘Financial sector reforms in India: Why? Why Now? How?’—January 2008:
“The current formal system is simply not serving a majority of our citizens, despite the tremendous steps taken in the past to expand the rural banking network, the grand schemes targeting rural credit, and the considerable attempts to impose interest rate ceilings to protect the poor against predatory lending.”
Rajan’s proposals to remedy the situation include:
1) “Allow more small banks: Higher risk is the price we will have to pay for more growth and inclusion. Excessive risk aversion imposed on the regulatory system will only hold us all back.”
2) “Competition and costs: By capping prices or interest rates at low levels, though, the government does not ensure the poor get low prices. Instead, it ensures they get no service and have to resort to very highly priced unsavoury alternatives.”
3) “Better thought out interventions: I believe we can create more access by creating more competition to provide services the poor want, and by reducing the costs through technological and organizational change.”
Rajan goes on to say: “I see little evidence that state ownership helps significantly in achieving public aims such as greater inclusion. It makes sense to rethink the state presence in the financial sector. It should be reduced at a pace consistent with the private sector’s ability to absorb it. Meanwhile, we should improve the public sector’s ability to compete, and protect the legitimate interests of public sector employees.”
From ‘The Global Crisis and Financial Sector Reforms in India’, March 2008:
“India should allow more foreign investors into the rupee bond market. Their expertise and risk tolerance can help deepen the market, and this will be an
important step in financing the enormous infrastructural needs that lie ahead.”
“A major source of concern in India are the state-owned public sector banks. While some of the finest bankers in India are to be found in public sector banks, their
inability to pay market salaries to top managers has eroded their strength. The chairman of the
State Bank of India, India’s largest bank, makes less than $1,000 a month in basic salary. The worry mounts as generations that were recruited in good times, when the public sector had a monopoly, retire.”
“Equally of concern is the fact that public sector banks are slowly but surely falling behind the new private and foreign banks. While public sector banks are still profitable because of their considerable reach, this advantage is likely to erode over time.”
“More generally, though, India needs to free up the banking sector. It needs to allow banks the freedom to open branches or ATMs anywhere, a process that is still controlled. It needs to allow bank mergers. And, it should treat domestically incorporated foreign banks on par with domestic banks. These steps will improve overall system efficiency as well as the quality of management. Clearly, the regulatory system needs to be upgraded to keep pace.”
“We also need to steadily expand the range of investments of pension funds and insurance companies, and improve their ability to evaluate and take on risks. Rather than compelling these institutions to be overly invested in government securities, India needs to allow them greater flexibility by moving to a prudent man rule, where fund management is evaluated on the consistency of investments with the objectives, rather than on the basis of realized outcomes.”
“For India’s continued political stability, it needs to draw more of the poor into the growth process, and this implies greater financial inclusion. Nearly 75% of the credit obtained by households at or below median income is from informal sources. It turns out that most of these loans, including those from friends and family, are at rates that exceed 36% a year.”
“We need to strengthen the consensus that fighting inflation is not only the job of the central bank, but it should be its primary job.”
6) ON NEW BANK LICENCES
From The Economic Times, 2 April 2011:
Former IMF chief economist Raghuram Rajan is not in favour of the government giving banking licence to corporate houses. “I think the old RBI policy of not allowing corporates banking licence was good one. I still stand by that. Whether it will continue with this or not is a different question,” Rajan, who is also an advisor to Prime Minister Manmohan Singh, said on the sidelines of an event in Mumbai.
He suggested that existing peers, like NBFCs (non-banking finance companies) and MFIs (microfinance institutions), should be given preference over corporates owing to their experience in this business. “If corporates are given licence, the regulator needs to ensure there is no inter-company lending, proper risk management processes are followed and there is enough transparency,” he said.”
7) FROM THE REPORT OF THE COMMITTEE ON FINANCIAL SECTOR REFORMS, 2008, HEADED BY RAGHURAM RAJAN
Some important proposals made by the committee include:
“Proposal 1: The RBI should formally have a single objective, to stay close to a low inflation number, or within a range, in the medium term.”
“Proposal 7: Sell small underperforming public sector banks, possibly to another bank or to a strategic investor.”
“Proposal 10: Be more liberal in allowing takeovers and mergers, including by domestically incorporated subsidiaries of foreign banks.”
Proposal 13: Bring all regulation of trading under the Securities and Exchange Board of India (Sebi).
In areas where multiple regulators share concerns about a market (for example, RBI has a legitimate interest in the government bond market), regulators will have to cooperate even after the supervision of trading moves to Sebi.”
And here’s the final one, from India knowledge @ Wharton, reporting on a 15 November 2007 speech on “”Reforming the Indian Banking System: Why It Is Important and What Can Be Done” at the University of Pennsylvania:
“Rajan dismisses the often-repeated contention that Indian banks must be doing something right because the country has so far not faced a single major financial crisis. “The RBI beat its drums and said we had no crises,” he said. “I wouldn’t focus too much on the lack of crises. There is always a risk-return trade-off.” He recalls that Korea, at one time, had the same per capita GDP (gross domestic product) as India’s, but today it is 16 times as big. “I would settle for a few crises on the way to grow to that level of per capita GDP,” he said.”
Well, with a plunging GDP, the plummeting rupee, a yawning current account deficit, deteriorating asset quality in banks and stubbornly high retail inflation, Raghuram Rajan couldn’t have wished for a bigger crisis. We wish him the best of luck in coming out of it.
