The Rajan effect

A lot has already been written about Raghuram Rajan, how good he is and what he should or should not do in his new role. But I can’t resist the temptation of adding my two cents worth, in keeping with the spirit of the business community.

Here are a few key pros and cons that I foresee, given Rajan’s background:

Micro vs Macro

Despite a recent stint at the IMF, Rajan is more of a micro-economist than a macroeconomist (a quick search for his publications in SSRN reveals this tilt). For the unaware, microeconomics is a branch of economics that studies individuals, businesses and markets (financial and non-financial).

Macroeconomics, on the other hand, deals with economy as a whole — in terms of GDP, unemployment, inflation, savings, investment and international trade. Most central bankers like Ben Bernanke and many of our own have been macroeconomists (or civil services cadre in our case).

The good news is that being a micro-economist one tends to put the interest of businesses first. This could well be what our country needs at the moment given that low business confidence is being seen as the root cause of all the evils that we are grappling with today. After all, it is businesses that provide bulk of the employment, which in turn boosts consumption and the economy. The area of doubt is how equipped he is to tackle the issues of currency deflation and inflation, which are more macroeconomic in nature.

Free market ideology

Going by his writings and the Chicago affiliation, Rajan does come across as pro free market in general, but with a few caveats. Despite his research, which pointed out the risks of the US financial system and studies on market failure, his solution seems to be more towards how to safely allow financial systems to fail rather than over-regulating them. This is concurred by his view that India has too much red-tape for business, in general, that could be stifling its growth.

In some sense, while the US may have too much financial innovation and too little regulation, I believe that Rajan sees India as having too less financial innovation and too much regulation. Given the micro-economist that he is, Rajan is likely to favour an equilibrium.

So, how could he unshackle businesses as a central banker? Well, to begin with, it will have to come through the banking and non-bank financial players on which the RBI exerts direct influence. I would argue that Rajan is likely to reduce the complexity of regulations governing our financial system so that they have more leeway in managing their capital, designing products and servicing their customers (individuals and firms), thereby improving their growth and profitability. This would then have a trickle effect on businesses and individuals.

Financial services to benefit

Clearly, the financial services space in India is bound to see a lot of action over the next few years. Who knows, financial sector reforms may finally answer the prayers of NBFC chiefs and bankers, such as T. T. Srinivasaraghavan and Pratip Chaudhuri regarding the regulatory wall that each is facing. This could provide a much-needed respite for our financial sector that is facing slowing growth and rising delinquencies. But, what is harder to predict is if such initiatives would improve market efficiency and financial inclusion or increase financial risk for the country as a whole.

Conditionality

One thing to keep in mind is that – for the free market system to work, there are various dependencies, such as transparency, market depth and effective legal system. Despite satisfying many of these conditionality’s, we have seen that mature economies like the US also require wise restraints to dampen greed and save the system from the actions of a few people. The challenge with India is that many of the conditions for free markets do not hold good – which is what makes for a curious case!

(The author is a business consultant. The views are personal.)

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