Why RBI chief thinks macroeconomic stability is the key to enhance growth

The lecture on ‘India in the global economy’ delivered by Reserve Bank of India Governor Raghuram Rajan, at the first Ramnath Goenka Lecture, invoked optimism and caution.

While Rajan endorsed the government’s fiscal management, monetary policy reforms and rural job creation efforts, he reiterated the need for differentiating between dealing with genuine risk-taking and deliberate wrongdoing while chasing mortgage defaulters, who have collectively dragged the banking system to a whirlpool. And moving out of this whirlpool has become the biggest challenge for the banks now and perhaps even for the economy.

Rajan stressed on RBI’s aim to have clean bank balance sheets by March 2017 so that banks have the room to lend again.

“The problem in the past was that banks did not have enough powers to force promoters to pay or to put stressed assets back on track… We aim to have fully provisioned bank balance sheets within a year,” he said.

Trying to answer the disturbing question of why the global economy has been finding it hard to restore pre-Great Recession growth rates, Rajan said the financial boom preceding the Great Recession left industrial countries with an overhang of debt.

“Debt, whether on governments, households or banks, holds back growth,” he said.

While the remedy may be to write down debt so as to revive demand from the indebted, it is debatable whether additional debt fuelled demand is sustainable. “Also, large-scale debt write-offs seem politically difficult even if they are economically warranted,” he warned.

According to Rajan, aggressive monetary policy moves by industrial countries have been putting a lot of pressure on emerging markets like India. “We are faced with surges of capital inflows one day when investors go into ‘risk-on’ mode only to see outflows the next as they switch risk off,” he rued.

For the first time in decades, global trade has consistently grown more slowly than global output. “As countries get richer, non-traded services constitute a greater fraction of GDP, causing GDP to grow faster than trade. Also, as industrial countries become more competitive, and as China moves up the value chain, more of the inputs going into final products are being sourced from inside a country rather than from outside the country, pulling down the global supply chain,” he elaborated.

This results in slower growth especially for countries like India. “If all countries are experiencing slower trade, the remedies may be beyond the control of the Indian government. While we can examine possible dumping in certain industries, we have to be careful that any remedies that increase prices in the protected industry do not render other domestic industries uncompetitive,” Rajan cautioned.

Though Indian trade has been slowing, the slowdown is similar to what has been happening elsewhere, with a significant portion due to a fall in commodity prices, and a smaller share due to a fall in trade volumes. “While goods exports may have suffered a little more over the last year, it is too early to discern a clear pattern,” he asserted.

Rajan is not unduly worried about the growing debate over rupee’s depreciation against the dollar. “Indian currency has been relatively stable in comparison to peers across the globe,” he said.

Rajan believes that three things can further help ensure that the movement of the rupee versus other currencies is orderly. “First, good policies that ensure macroeconomic stability and convinces investors their money is safe over the medium term. Second, we should focus on attracting stable capital flows that will stay for the long run. Finally, the government has been encouraging foreign investors to ‘Make in India’. One offshoot of this campaign has been a sizeable rise in foreign direct investment, the most stable sort of investment. With two months left in the year to go, net FDI is already at the second highest level ever, and comfortable higher than the current account deficit.”

Rajan does not subscribe to the idea that exchange rate is a helpful tool in the country’s quest to enhance what is produced in India. “Instead, to export more, the country should improve productivity by building out infrastructure; improve human capital with better schools, colleges, vocational and on-the-job training; simplify business regulation and taxation; and, improve access to finance,” the RBI chief said.

Rajan said at a time of increasing uncertainty over the strength of the economic stability and progress globally, the country’s approach to stick to the path of macroeconomic stability has made a clear difference. “Given the inhospitable world economy and two successive droughts in India, either of which would have thrown the economy into a tailspin in the past, our focus on macroeconomic stabilisation must be part of the explanation why we have over 7 per cent growth, low inflation, and a low current account deficit unlike some of our emerging market counterparts,” he said.

(Image: Indiatimes)