The Rajan-niti : a synopsis of Rajan’s speech

Why this dramatic title you might ask ? What is the point ? Well the thing is Raghuram Rajan , the RBI governor seems to be the media’s new controversy king and has been in news for all the wrong reasons. Be it the one-eyed King remark in Washington which drew many eyeballs(or say eyeball ), or Subhramanyam Swami’s accusation that Rajan in not ‘Indian enough’.  Despite all there controversies , Rajan continues to be India’s most popular and arguably most industrious  top banker so far.

Rajan had been to Odisha my home state a few days back and i got the opportunity to listen to him speak on “World Economy and India”. He really needs no introduction. Born in India Rajan went to IIT Delhi , then to IIM, Ahmedabad. After a brief stint in the Tata Administrative Services, Rajan went to Chicago Booth School of Business, one of the world’s top B schools for a doctoral program. Consequently he worked at IMF as the Chief Economic Advisor. He has served in various ranks like Member of the planning commission and Chief Economic Advisor to India, before taking up this significant position.

Here is a reconstruction of his speech, from whatever I had scribbled on my notepad.

Big question and 2008 recession

Rajan began by raising an important question, which has perplexed economists all across the world. Despite all the monetary policy and fiscal manoeuvres why are we not growing as fast as we could. In this context he went on to talk about the 2008 global financial crisis (he was the first one to predict it), and how this sounded the death knell for many economies. 2008 crisis was fuelled, inter-alia, by the fact that loans(primarily housing  loans) were doled out to everyone who had a job without evaluating his credentials, at low interest rates ,in developed countries. This sparked a demand for property, thereby further driving real estate prices high. It consequently became a way of making easy money by short term buying and selling. A point was reached when sellers outnumbered buyers and the bubble burst, perpetuating the 2008 global recession.

This led to re examination of monetary policy. Interest rates were now hiked and lending was restricted. Money flow into the economy was curtailed. This decreased the purchasing power of the developed countries across the world.  Now the countries who had an export driven growth model  took a beating. The price of final goods in the market were low, because of low demand and ergo, the recession continued, this time in developing counties. Counties like China and Latin America were the primary victims.

This brought Mr. Rajan to his first conclusion. It is difficult to grow during a global slowdown. We might want to cut interest rates and give a new headstart to the economy but it isn’t going to happen when the world outside is in shambles. This is the time for macro-economic stability.

Reasons for slow growth

Rajan outlined concrete points which explain  our inability to grow

  1. Quality not taken into account while calculating growth quotient – This according to Rajan is the problem of the subject of economics itself. The inability to map quality in calculating growth figures, ensures that out technological enhancement doesn’t reflect on the GDP. Colour TV’s a decade back and LED tvs today might be worth the same amount of money, but the value-added by the LED tvs to our lives is not being taken into account. Therefore the GDP contribution back then and today hypothetically will be the same
  2. .Innovation cannot be monetised and this is a major impediment in GDP calculation. Today there is a Youtube revolution happening where there is content online for free. Its impossible to put this in monetary terms and thereby account for it in the growth trajectory. If its good or bad is debatable, but GDP is not being affected.
  3. A dangerous trend is financing sick industries. Now there are a few industries which are not making a lot of profit , but the government wants to keep them running. There are interests of workers involved and shutting such industries down is difficult. What this inturn does is, it eats into the space for new start-ups. Growth is abridged when new players are not allowed to come in.
  4. Another major problem is Oligopolies: Oligopolies are giant companies which have a big chunk of market share. Such Oligopolies often try to eliminate any new competition that tries to spring up .Facebook bought Whatsapp recently. Takeovers and acquisitions by giant corporates is common and this curtails growth.
  5. The debate about patents is another important debate Mr Rajan looked into. Patents are proprietary rights over any design or technology. Flexible patent rights would have given scholars easy access to technological advancements and thereby sparked further innovation. Hence what is good for the people may not always be good for the economy and vice-versa.


Having examined all the reasons Rajan looked at the solutions

  1. Structural reform: Rajan called structural reforms life blood of the economy. He quoted many important initiatives by the government like the GST bill, the Bankruptcy Code etc. There is need for big-bang reforms to inspire faith in investors and improve ease of doing business according to Rajan.
  2. Competition regulation : Competition must be regulated to restrict monopolising by any big corporate entity. Rajan touched upon the net-neutrality debate and how this can seriously hamper interests of start ups in India. Also the issue of Taxi aggregators vs Taxi drivers received his attention. Oligopolies abound in the economy today and can stifle the growth of start-ups and new initiatives.
  3. Stimulus by cutting interest rates : Well this can be a little controversial. Cutting interest rate on loans may lead to injection of money into the economy , sparking growth. But the growth might not be sustainable. The bubble like the housing bubble may burst. This may lead to further debt. The economy will consequently have to take austerity measures like Greece had to. Further the low interest rates may lead to capital investment in sick industries which hardly yields any profit. Infact oligopolies might just stifle growth by not allowing start-ups to gain ground. Another important factor to account for is the fact the investment is yet to pick up in countries with alarming low(sometimes negative) interest rates. One reasonable explanation could be the fear that a huge national debt due to debt financing may lead to austerity later, and this may coax the common man to save money than invest in anything.

Aggressive monetary policy and its net effect

Having talked about growth, Raghuram Rajan went on to talk about the role of monetary policy across the world in giving a fillip to growth. Answering criticisms for not cutting interest rates, Rajan pointed out that the net benefit of aggressive monetary policy(really low interest rates) might be negative, as the aforementioned examples suggest.

What happens as a result of low interest rates is that capital flows from a place of low interest rate to an economy with high interest rates. This means  imports become cheaper but exports become expernsive. Here is where depreciation comes in. Depreciating  your currency may improve exports(think China) , but this in the long run may hurt other countries. If all countries depreciate, no one depreciates at all. So the point is aggressive monetary policy (which has been the bone of contention of the RBI ), given that it has been in operation for a long time, is effective in the currency channel rather than on domestic investment. In a word the critics fear is unfounded.

Talking about the issue of global economy further, Rajan talked about the effect one country’s aggressive policy can have on other countries (China example). This results in a blame game of sorts. The sad part is no clause and central bank functions says that the bank must keep the interest of the world economy in mind. This means there is a rat race of sorts with everybody aiming for growth but the net outcome is inconsequential.

Talking about quantitative easing next, Rajan tried to sum it up this way. The government tries to spur growth by spending more and it does this by the money it gets from the central bank by selling treasury bills(bills saying the govt will pay you back). An interesting idea Dr Rajan talked about was this concept was the idea of helicopter money( you print a lot of cash and throw it into the city from a helicopter). Will this help pick up investment and consequently growth, is debatable. The common man might just save the money he got, unsure of what the government or central bank might do next. So these factors lessen the credibility of banks. Easy money is never the answer to any question.

Global responsibility and spillovers

The thing with foreign investment according to Rajan is that it may disappear overnight and if we absorb all the money and send nothing back as foreign reserves we run a huge risk . So what we must acknowledge is that the net effect of these policies might as well be negative. So what must be done in such a situation ? Here we must look at the rules of the game. Today central banks are only concerned about hurting other economies if there is a spill back i.e. it hurts the country’s ability to import from my country. Spillbacks i.e. hurting other country’s industry etc is not taken into account. A little part of the central banks mandate should be about taking into account the health of the global economy as well and avoid spillovers, and not just aggressive monetary policy to meet domestic demand. Some serious debate should be happening in this regard and a few policies ( like depreciating too much ) should be legally ruled out for everybody’s benefit.

What the RBI should and must do , is speak out louder against these policies of industrialised nations. We need to be part of the global agenda setting. Demanding more quota in the IMF is only part of the lobbying, a quota gives you a little more voting power, if at all there is a vote.  We need think tanks and universities to examine, spillovers and suggest alternatves.

Growth with macro-economic stability

Focusing on the end of the speech on domestic market, Rajan appreciated Make in India, but said we must also be willing to sell in India. The global economy is fraught with uncertainties. We must avoid the path other emerging markets have taken, of unsustainably increasing their capacities later resulting in plummeting growth later. Growth should be inclusive and sustainable. There is need to keep inflation under check ( Rajan has come under attack for stressing too much on inflation). There is need for   cleaning up the banks, which have come under a serious NPA(Non-performing assets ) situation (a feat Rajan is credited for ). If we create a macro-economically stable environment investors will be willing to lend to India.

Reform must also be stressed on , and make India a better place to invest in . In our defence against global instability, good policy is the first line of defence. We must spark confidence in the rest of the globe.


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