Rajan, one of India’s key reform figures, is stepping down in September. His three-year term wasn’t extended despite his important role in helping restore investors’ faith in the way the economy is run.
Inflation has fallen under his watch, as have interest rates. Foreign exchange reserves of some $362bn are near record levels. Problem loans in the banking system are finally being tackled. The country has been one of the greatest beneficiaries of the windfall gains from cheaper oil, but government finances are healthier too.
The days when India was derided as a “Fragile Five” economy seem long ago, and the country is now feted as one of the few shining stars within the emerging markets constellation.
Rajan represents that rarest of things in emerging markets: a public servant whose competence is admired around the world; whose private affairs are untainted; someone who speaks his mind and is free from inappropriate political influence.
However, he also alienated some in the ruling Bharatiya Janata Party by being so outspoken and because of his refusal to cut interest rates at a faster pace – a move that would score points with voters but risks conceding ground in the fight against inflation.
One serious constraint to reforms has been the inability of the state-controlled banks, saddled with bad loans, to support investment. Rajan forced the country’s lenders to conduct asset quality reviews as the first step towards identifying and dealing with these loans – a long and painful process that is unpopular with some of the country’s most powerful businessmen.
A credible successor will ensure that, when the going gets tough, the task of cleaning up bank balance sheets isn’t quietly swept under the carpet.
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While the markets may welcome the prospect of more central bank stimulus – the stock market has actually strengthened since Rajan’s departure was announced on 18 June – excessive easing will undermine the monetary policy discipline that has been a hallmark of his tenure.
What India also doesn’t need is a compliant governor who will only weaken the central bank’s independence. Rajan’s successor needs to have the courage to eschew the quick-fixes beloved of politicians and champion lasting solutions.
That said, the wheels of reform are already in motion. Many of Rajan’s most important achievements – a credible Monetary Policy Committee, inflation-targeting and the overhaul of bankruptcy rules – are backed by legislation and have Modi’s support. This will help ensure policy continuity.
Those who have been linked to the job include: Reserve Bank of India deputy governor Urjit Patel; former deputy governors Rakesh Mohan and Subir Gokarn; the government’s chief economic adviser Arvind Subramanian; economic affairs secretary Shaktikanta Das; vice chairman of the NITI Aayog, an economic think tank, Arvind Panagariya; and State Bank of India chair Arundhati Bhattacharya.
Whoever is selected, however, will face a potential early test amid growing doubts about the global recovery. While India’s capital markets are relatively insulated, the country relies on foreign investment and isn’t immune from the forces constraining global growth.
Rajan, a former IMF high-flier, grasped this instinctively. His successor may be more of a New Delhi insider, but he or she must strive to be outward-looking. Otherwise the country risks squandering its hard-won gains.