The Rajan behind the unscheduled rate cut

By Biswajit Choudhury

Weeks ahead of schedule, Reserve Bank of India (RBI) Governor Raghuram Rajan cut interest rates for the first time in almost two years on the day data showed the December trade deficit had fallen to a five–month low on account of plunging crude oil prices.

Though he may be described as a “rockstar banker”, it is important to understand where Rajan comes from in the face of this “unscheduled” rate cut, which can also be called uncharacteristic given his monetarist moorings.

When Rajan took charge at RBI in 2013, at a time the US Federal Reserve had declared its intent to wind down its stimulus programme, the rupee plunged in value in respect of the US dollar on fears about a spiralling current account deficit.

In a series of measures, Rajan maged to stabilize the currency that also brought back investors. “Rajan’s disciplined and focussed approach in leading the Reserve Bank during his first year as governor was remarkably impressive,” British magazine Central Banking said earlier this week giving Rajan their central banker of the year award for 2015.

“His decisive policy actions based on robust alysis and deep understanding of the underlying causes have contributed significantly to changing perceptions about the strength of the Indian economy,” said editor Christopher Jeffery.

Rajan had predicted the 2008 markets crash caused by the housing market crisis in the US that put its economy into deep recession setting off a global slowdown. In 2011, he published the acclaimed Fault Lines on how hidden fincial fractures threaten the world economy.

The RBI on Thursday cut the repo rate at which it lends to commercial banks by 25 basis points to bring it down from eight percent to 7.75 percent. The Indian basket of crude oil had traded on Wednesday at $43.36 per barrel, having already touched a five–and–a half–year low.

The wholesale price index data for December 2014, also released on Thursday, showed that inflation is easing, while Rajan’s unscheduled relaxing can almost be attributed as a move to calm the clamour for a rate cut that was growing in proportion to oil’s precipitous slide.

A key element of the context Rajan finds himself in is the market, where the Bombay Stock Exchange shot up 729 points on Thursday on news of the rate cut. At the same time the biggest fall in the stock market in five–and–a–half years last week was sparked by crude oil going below $50 a barrel.

While the demand–supply situation is a factor in falling oil prices, the other is fincial market equations. The oil market in recent years has been sustained by cheap dollars flowing out of the US Federal Reserve’s quantitative easing (QE) programme. With the announcement of QE “tapering” towards winding up the stimulus programme, funds are now flowing out of commodities, pushing prices down.

Predicting the 2008 fincial meltdown that is still affecting global economy, Rajan, in 2005, had argued that increasingly complex markets with myriad instruments of credit and mortgage–backed securities in ever greater quantities had made the global fincial system a risky place.

Almost a decade down the line, Rajan is stronger in his belief that global markets now are at the risk of a crash due to the competitive loose monetary policies being adopted by developed economies.

Pointing to the very low interest rate policies of the US Federal Reserve, the Bank of Japan and the Bank of England in a bid to stimulate their economies, Rajan has been warning that emerging markets are especially vulnerable to big shifts in capital flows triggered by the unprecedented monetary accommodation in rich countries.

Comparing the current situation to that before the Great Depression of the 1930s, Rajan told Central Banking Jourl last year: “Unfortutely, a number of macro–economists have not fully learned the lessons of the great fincial crisis. They still do not pay enough attention – en passant – to the fincial sector. Fincial sector crises are not as predictable. The risks build up until, wham, it hits you”.

Describing the mainspring of the 2007–08 crisis, former British banking regulator Lord Adair Turner has said that influential economists who a decade ago were convinced of the benefits of the capital regime were convinced that a banking system overweighed by debt was good for the economy.

“The fundamental mistake was to allow banks to do far much more business compared to their capital stock. There wasn’t enough capital with the banks,” he said on a television debate on capitalist crises.

In fact, Turner said the roots of the crisis go back to the deregulation of US banks 30–40 years ago. “There wasn’t enough attention given to the trend of the fincial system developing to get bigger and bigger. The overall level of leverage (debt) grew much larger in relation to people’s income,” he said.

Though he may not be a subversive in the way such an element is part of rock music, Raghuram Rajan is certainly not blind to the inherent weaknesses of the system he is a pillar of. IANS

(Biswajit Choudhury can be reached at

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