India’s wizard central bank governor pushes economy to critical crossroads

Reserve Bank of India Governor Raghuram Rajan, aka prophet of financial doomsdays, faces warning from a grocer near his office after his slashed interest rates pushed India back to inflation risks– ironically the same risks from which he was rescuer-in-chief.

RBI Governor Raghuram Rajan

RBI Governor Raghuram Rajan

At the inexpensive “Apna Bazar” co-operative stores across the road from Rajan’s Reserve Bank of India (RBI) headquarters in Mumbai, the price of dal (lentils) hit historic high of over Rs 100 a kg this week. In effect, as local news merchants stressed, chicken is now cheaper food in many Indian cities than the staple dal — something that has never happened in this lifetime.

It’s a contradiction in Rajan’s war against inflation. Usually “dal-roti,” or “dal-chawal (rice),” is sub-continental equivalent to “bread-butter” in language of daily living. Urban families with humblest incomes could afford it. Not anymore, in the world’s fastest growing economy.

The more apparent reason for pulse prices shooting skywards would be an erratic monsoon ruining crops. But with food bills being indicators to inflation, the dal prices seem soaring like poetic justice to Rajan rejecting his own regulatory codes.

In September Rajan lowered repo rates (the rate at which the regulatory bank lends to commercial banks) by an unexpected 0.5 basis points to 6.75%, the biggest reduction since 2007. It was the RBI’s fourth rate cut this year.

Expectedly, the stock markets went into raptures. But RBI cutting benchmark repo rates also hit small savings, the dependents who live on interest from commercial banks. Banks have to compensate for their cheaper lending rates, meaning less money for pensioners — a bit like Robin Hood taking from the poor to feed the rich.

Indian market

Indian market

In rich irony, Rajan had explained his unexpected surrender saying: a) inflation hitting a nine-month low in August; b) in spite of an erratic monsoon and damaged crops, the government’s supply-management policies contained food inflation. Dal prices in Apna Bazar though tell a different story.

It’s an unconvincing u-turn for a man reputed to be one of the world’s more talented economists. Rajan’s claim to fame was his sensational speech during Alan Greenspan’s farewell event in Jackson Hole, Wyoming, in 2005, when he predicted the global financial crisis of 2008.

Rajan rescued India from an inflation crisis as RBI Governor. He helped drag retail inflation down to 3.78% in July 2015 from 9.8% in September 2013, the lowest in over two decades. Wholesale inflation dipped to a record low of -4.05% in July 2015, from 6.1% in September 2013.

Has RBI's Horatius abandoned the bridge?

Has RBI’s Horatius abandoned the bridge?

Now Dal Fry inhabiting same price zones as Chicken Fry may be portend of worse to come, a symbolic slap in the face of Rajan’s stirring struggles to kill inflation.

It was a struggle that conjured images of Rajan as the sixth century Roman hero Horatius standing alone defending the last bridge across River Tiber, and saving Rome from the Etruscan hordes.

The RBI Governor was the last line of defense against fierce onslaughts to keep cutting interest rates – and replay conventional calamity patterns:  high consumer spending amid mismatched demand and supply equations, leading to runaway inflation.

Now RBI’s Horatius has walked away from the bridge after months of resisting assaults from Arun Jaitley, India’s corporate lawyer turned Finance Minister. Jaitley had earlier tried reducing Rajan’s voting powers in the Monetary Policy Committee that decides on interest rates.

Shifting his known deregulatory stance, Rajan had continued the unsung good work of earlier RBI governors and their safeguards ensuring regulatory sanity (See Red-tape safety knot for India’s bankers, Asia Times, September 19, 2008).

Now Rajan’s about turn appears more peculiar as only the previous month he had warned against the RBI dancing to market tunes. Central banks should avoid boosting the stock market by cutting rates, he said. “We do not have to look too far beyond our borders to see the consequences of such boosterism,” Rajan told executives and bankers in Mumbai on Aug. 20.

In effect, Rajan warned against India’s healthily growing economy running into storms like China’s current stutters or the US national debt ticking at $18.4 trillion.

For past three decades, the RBI and its regulatory safeguards ensured India safely sailed through global financial disasters like the crash of 2008. Conservative interest rates protected India from subprime crisis of the kind the US saw in 2007-2008.

Rajan had experienced such crisis of the US economy firsthand. Currently on leave as Professor of Finance at the University of Chicago, he was earlier chief economist at the International Monetary Fund (the first non-westerner in this job), and had finished his post-graduation at the MIT Sloan School of Management.

Unfortunately, Rajan’s critical rate cut was timed at the start of India’s annual festival season, from Durga Puja later this month to Diwali in November. The country in any case sees maximum consumer spending this phase of the year.

Right on cue, e-commerce behemoths like Amazon are advertising billion-a-day sales like the Chinese conglomerate LETV that sold a record 1.7 billion yuan ($280 million) worth of electronic goods on September 22, 2015. India’s E-tailers expect a record $6 billion in sales this festival season.

After the feast may come the reckoning: In August, Rajan predicted inflation relapse would follow cutting interest rates.  In September, he cut rates. October is posting record consumer spending. By December, soaring inflation may return to snarl growth, his own prediction that Rajan and India’s economy can hope would not turn true.

Raja Murthy is an independent journalist who shuttles between Mumbai and the Himalayas.

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