#dnaEdit: Getting Rajan right

There is fear as well as frustration in India about the lingering Great Recession, which had begun with the financial meltdown in 2008. Last week, when the Reserve Bank of India (RBI) Governor Raghuram Rajan talked about yet another impending “Great Depression”, people did not wait to find out what exactly that meant. They panicked, and interpreted his warning to mean that the present Great Recession is going to slide into the Great Depression of the 1930s which witnessed a catastrophic economic breakdown of the capitalist system. Rajan’s actual post-speech formulation was: “...I do worry that we are slowly slipping into the kind of problems that we had in the thirties in attempts to activate growth.” 

It may be worth recalling how nearly a decade ago, Rajan had warned the United States, of the 2008 financial meltdown. Following the crash, the economist was worried over the policies the central banks in advanced economies had adopted, of buying into falling shares of the failing investment banks in order to prop the shares because of the fear that their continued slide  would trigger a bigger economic crash. One of the major effects of the 2008 recession was a contraction in the markets, with demand dwindling and investments shrinking. 

To cope with this aftermath of the meltdown, the central banks, especially the United States’ Federal Reserve, reduced the interests to the point of zero to stimulate credit outflow and boost demand. However, instead of encouraging investment, the monetary policy in the developed economies only triggered capital flight to emergent markets where the demand for investment was greater and the interest rates were better. If the US Federal Reserve were to increase interest rates, there could be reverse capital flight from the emergent markets like India. 

For more than a year, Rajan has been arguing that the unconventional monetary policies (UMP) adopted by the central banks in the West to focus on their own national economic imperatives, are short-sighted. The RBI governor anticipates problems if each central bank were to adopt a policy that is best suited for national interest. Here is how Rajan succinctly explained the issue in his speech: “The current non-system in international monetary policy is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector. It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action. We are being pushed towards competitive monetary easing and musical crises.”

He is of the firm view that there has to be an informal but firm coordination among the central banks with regard to monetary policy, which is difficult to achieve. Though Rajan sees the need for reducing interest rates at home to boost growth, he is literally looking over his shoulder about the impact of a hike in US Fed rates because that would impact foreign capital flows into India. 

As RBI governor, Rajan has been under consistent attack from the government and from industry for holding on to interest rates. Yet, he has steadfastly maintained that Indian economic growth cannot be autochthonous, and that it is dependent on the global economic climate. It is in this context of the debate around chasing higher growth, that there is need to pay attention to Rajan’s arguments — and understand what he is saying.