Richard C. Longworth
Raghuram Rajan, the Chicago economist who is now India’s central bank chief, told The Chicago Council Friday that India has laid the basis for long-range stability after three years of slowing growth, falling reserves and high inflation.
“Is everything hunky-dory?” Rajan asked. The answer, he said, was no, partially because of India’s home-grown problems and partly because of global financial trends, including policy moves by America’s Federal Reserve Bank, that can almost inadvertently upend emerging economies.
Rajan, now on leave as a professor of finance at the University of Chicago’s Booth School of Business, returned to his home country in 2008 as economic advisor to the prime minister. For the past year, he has been governor of the Reserve Bank of India and is given much of the credit there for turning around his country’s flailing economy.
Rajan is probably best known as the economist who publicly predicted in 2005 – before an audience that included the then Fed President Alan Greenspan – that the booming American economy was riding for a fall. In effect, he predicted the 2008 sub-prime mortgage crisis. Widely ignored then, he has since become celebrated as a financial visionary.
Most recently, Rajan has written of his fears that Fed policy – especially, its expected “tapering” of its zero-percent interest rates and other stimulative policies – could touch off capital flight and a potential crisis in emerging economies such as India. This criticism – that the Fed and the European Central Bank respond to domestic needs without thinking of the global impact – underlay much of what he had to say here about India.
But India – “where India is coming from and where it’s going” – dominated his talk to 400 Chicago Council members at the Ritz-Carleton Hotel. Basically, he said a policy of focusing on fundamentals will make it a good candidate for foreign investment.
But to get there, he said, it had to survive “a perfect storm” of economic turmoil, some of it caused by the global recession rooted in American mistakes.
When the recession hit, he explained, India responded by stimulating its economy. It worked – too well. After a year of low growth, the economy boomed. By 2011, he said, India was “hot.”
But the stimulus was excessive, he said. The result was high inflation – more than 11 percent in 2013. Real interest rates turned negative. Worried investors imported 350 tons of gold. The nation’s current account deficit swelled from two percent of gross domestic product to 6.5 percent. Social policies enacted during the boom years became unaffordable. A country with a vast poverty problem had to support its poor people “without stopping business in its tracks.”
Growth that had been eight percent per year slowed to fivepercent or less, which in an emerging economy like India looks like “stagnation.” At this moment, with inflation up and savings down, the US Fed began signaling that its policy of “quantitative easing” would be ending. With negative interest rates at home and the prospect of higher rates abroad, money began to flow out of India, undermining the value of the rupee.
This was when Rajan took over India’s Reserve Bank. His job, he said, was to “change the conversation and talk about fundamentals,” to get money to flow back into the country.
He targeted inflation, which is now down to eight percent and should be six percent next year, he said. He clamped down on gold imports, part of cutting the current account deficit, which is 4.1 percent of GDP now and falling by a half percent per year.
In the last quarter, he said, India’s economy grew by 5.7 percent -- good, but not good enough. It should be six percent next year and, after that, “into the sevens.”
More reforms are needed, Rajan said. These include a banking system that reaches more Indians, new financial market instruments to ease the risk burden on banks, and a more efficient bankruptcy system. Too much money is stuck in stalled government-financed projects which must get back on track.
All this, Rajan said, “is not sexy, but it will pay dividends.”
But the economist who predicted the Recession warned of a new crisis building -- again with Western central banks at the center.
These banks have a legal mandate to look after their own domestic economies, Rajan said. So they too often act for domestic reasons, without considering the impact abroad, especially on poorer nations.
For instance, if interest rates rise in the US and Europe, he said, this could send money pouring out of India and other emerging markets. The emerging countries will try to protect themselves by building up their reserves, which in effect removes liquidity from the global economy. This, in turn, depresses global demand, he said, at a time when that demand already is too low.
Richard C. Longworth is a senior fellow at The Chicago Council on Global Affairs. Read more of his program summaries and recent publications or follow his blog.