India on Tuesday turned to former IMF economist Raghuram Rajan to run its central bank as the government of the world’s second-most populous country sought to tackle its most serious economic problems in more than two decades.
Rajan will take over at the Reserve Bank of India early next month amid fears that the much-debated phasing out of the US’ stimulus package will push up the value of the dollar and trigger a currency crisis in emerging markets.
With India the worst-performing emerging market economy since the turn of the year, the arrival of one of the few economists to have forewarned about the risks posed by the speculative activities of global banks has been welcomed by analysts.
In a brief statement Rajan acknowledged the scale of the challenge he faces during his three-year term. He said that while there was “no magic wand to make the problems disappear instantaneously,” the government and the central bank would work together to overcome the difficulties.
The new governor will arrive at a time when India faces a cocktail of economic problems — slowing growth, saoring inflation, a wider current account deficit and an expanding budget shortfall — that has prompted comparisons with the crisis of 1991, which triggered widespread reforms in Asia’s third-biggest economy.
After being one of the emerging world’s star performers during the financial crisis and its immediate aftermath, India has recently been suffering from a form of stagflation. Consumer prices are rising at an annual rate of almost 10 percent, while the latest forecasts from the central bank suggest that growth came to a standstill in the second quarter.
Monetary policy has been tightened in recent months in an attempt to stem the fall in the value of the rupee, which hit a record low of 61.80 against the US dollar on Tuesday before rallying slightly on the news of Rajan’s appointment.
“He has the intellectual pedigree and policy experience but my worry is people will think a smart guy coming in will fix all of India’s problems,” said Bhanu Baweja, head of emerging markets strategy at UBS in London.
“The problem in India is political consensus and execution. By itself the appointment doesn’t change my view on the market. I am underweight the rupee and Indian equities,” he said.
Shweta Singh at Lombard Street Research said India’s twin deficit — the current account and budget deficit combined — stood at 12 percent of national output, just shy of the 14 percent of GDP recorded during the 1991 crisis.
“With quantitative easing tapering [in the US] the talk of the town, investors are getting increasingly wary of financing the deficit and a potential rerun of the 1991 crisis,” Singh said.
India’s new central bank governor was the chief economist at the IMF in the bubble years of 2003 to 2006, and warned that the flawed business model being used by the financial sector could lead to a collapse. His warnings were dismissed at the time, with Larry Summers — tipped to take over from US Federal Reserve Chairman Ben Bernanke — describing them as “misguided.”
After leaving the IMF, Rajan returned to academia in the US before becoming senior adviser at India’s Ministry of Finance last year. In retrospect he has been hailed as one of the few senior policymakers to identify the dangers involved in banks allegedly laying off risks through the use of highly complex financial instruments.