Raghuram Rajan, the new head of India’s central bank, has become the man who has to fix the country’s weak currency. The rupee has fallen 17% in the past six months, raising fears about inflation, and more importantly, about economic growth.
Immediately after taking over as the 23rd governor of the Reserve Bank of India on September 4, Rajan announced among other measures, a special window to swap foreign currency non-resident dollar funds mobilised by banks and spoke about liberalising the banking sector. Most analysts see an immediate fund flow of as much as $10bn due to the swap window.
The “Rajan effect” is not lost on markets. The rupee rallied 2.2% from Friday to 63.84 per dollar yesterday. The currency, which fell to a record 68.845 on August 28, climbed 6% in the past four days, the most since at least 1973, according to Bloomberg data. Stock markets seem very optimistic too. The benchmark Sensex index rallied over 1,700 points in 4 days, 727 yesterday alone, to cross the 20,000 mark.
Time to think the former International Monetary Fund chief economist is the miracle man to drive India’s ailing economy out of its worst financial crisis since 1991? Have a closer look at the deeper issues. The current account deficit has widened to a record 4.8% of the GDP in the year through March, while growth has eased to 5%, the slowest in a decade. The economy grew just 4.4% in the quarter ended June, the weakest pace since 2009. Global funds have cut Indian debt holdings by $10.2bn since May 22, when Federal Reserve chief Ben Bernanke first flagged a potential paring of its stimulus programme.
India’s government debt has reached about 66% of its GDP. Compare it with Indonesia’s 24%, Turkey’s 34% and the Philippines’ 43%; the country is now in an unenviable position.
Things are likely to get worse. Moody’s has pointed out that India’s $20bn food security plan will come at a greater cost to the already-indebted government. The country is also facing the threat of becoming the first of the Brics nations to lose its investment credit status.
Analysts say Rajan, known for forecasting the 2008 global financial meltdown, can provide only symptomatic relief by using various mechanisms to lure in overseas funds. The government holds the key to reviving economic growth through structural reforms. But with federal elections due by next May, the ruling Congress party is sure to go soft on hard decisions. Add to that a highly probable scenario of a fractured electoral verdict; the economy is in for prolonged uncertainty.
Barely one week into the job, it’s too early to judge a celebrated economist with impeccable credentials just on knee-jerk market reaction. The former top finance ministry adviser has sought to temper high expectations, saying he has “no magic wand.”
It may take many more weeks, even years, to really see what Rajan is made of. But in an economy where even basic structural reforms are largely governed by short-sighted electoral politics, he’s sure to find the going get really tough. The key question for now is how long he can keep the bulls running.