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Portfolio > Economy & Markets

New Central Bank Governor Inspires Confidence in India Despite Structural Challenges

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The international financial community has welcomed the appointment of Raghuram Rajan as governor of the Reserve Bank of India (RBI) with great optimism, and many believe that this highly accomplished economist and financier may have some of the right solutions to help redress India’s macroeconomic woes. Rajhan was also the youngest chief economist at the International Monetary Fund (IMF).

Like many other emerging market nations, India has been suffering from a serious balance of payments crisis over the past months as global capital has shifted course. The ensuing sharp plunge in the Indian rupee has seriously hurt the economy, putting significant pressure on Indian corporates, and the country is facing lower growth prospects as well as twin deficits, prompting some to wonder whether the Great India Growth Story may be coming to an end.

Rajan’s appointment, though, has improved market sentiment and that, together with a series of measures he announced immediately after taking over at the RBI, have stemmed the rupee’s downturn. Rajan has also announced a plan to revamp India’s banking sector.  This plan is expected to make it easier for banks to operate in India, giving them freer rein to open branches and extend credit, according to , Sanjeev Kumar, director and group CEO at Delamore & Owl in London, a firm that helps foreign businesses look for investment opportunities in India and other emerging markets. This in turn will help spur economic growth and make India more attractive to both foreign as well as domestic enterprise, he said.

“While the RBI cannot pitch India to investors, it can create a conducive environment for investment by influencing the local business climate,” Kumar said. Market players are still extremely interested in India, and despite the macroeconomic problems the country is facing, many investors are buying assets in various sectors because valuations are attractive, “so in my opinion, the India story isn’t coming to an end,” he said.

However, portfolio investment by institutional investors isn’t going to suffice in the long run, and making sure that India offers a venue for sustained foreign direct investment is the challenge that the country must now take on.

“India now needs good policy makers to make the right decisions, because if these aren’t taken now, then it’s going to be disaster for the country,” Kumar said. “India’s challenge is to get people who are willing to commit capital to the real economy, and to the extent that Rajan can enable this, India will be much better off.”

Inviting investment into the real economy starts with encouraging local entrepreneurship, and Rajan is already making sure that that happens by removing the restrictions that force banks in India to buy government securities, thereby freeing up capital on their balance sheets that can be extended to more borrowers, which will “create a sort of tailwind for the economy,” Kumar said.

Tackling government subsidies that have been poorly directed, as well as coming up with measures to narrow the current account deficit and encourage a more inclusive financial sector (even today, much of India remains unbanked, Kumar said) are also on Rajan’s list, and will help India in the long run.

However, Kumar also warns that Rajan is not going to be India’s miracle worker, and although he has said that India’s current problems are not structural in nature, Kumar isn’t so sure.

“I feel that many of India’s issues are self-inflicted and have resulted in the crisis situation we’re in now,” he said. “There is only so much one can blame on global volatility. In my view, India’s problems are inherent to the system and to the Indian economy.”

Because India relies so heavily on imports, especially oil, and has been paying for the bulk of these through foreign exchange, the fall in the rupee’s value has been all the more dramatic, Kumar said. Last year, India’s import bill was around $155 billion dollars, compared to $142 billion in exports. The government has made some inroads into settling a greater number of oil imports exclusively in local currency, which would reduce the pressure on foreign exchange reserves and help in reducing the current account deficit, but these sorts of measures are not within the RBI’s mandate and they are extremely important for India’s future, according to Kumar.

While there has been some reprieve of late on the pressure that emerging market currencies like the Indian rupee have been facing, the right kind of policy framework to set the economy back on track is extremely important.

“Policy management will be the key factor in determining whether economic and financial stability is maintained in India and Indonesia,” rating agency Fitch Ratings warned in a recent statement. “Demonstration by the authorities that they remain committed to managing policy consistent with sustainable growth would support credit profiles.”


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