Why Raghuram Rajan Believes Low Rates Aren't the Only Growth Pill

When it comes to interest rates, mum is the word for any central banker ahead of the credit policy. And the RBI Governor is no different.
 
But he is one central banker who is known to speak his mind. Every word he says makes policymakers sit up and take notice.
 
"I know these cameras are here not to see me speak on core competencies but on interest rates - so let me offer my standard disclaimer," RBI Governor Raghuram Rajan told a hall packed with industry captains, economists and mediapersons while delivering the CK Prahlad Lecture in Mumbai today.

"For any hints of what we may do in the upcoming policy, please read the guidance in our last policy."
 
The timing of his lecture today was key for two reasons - the RBI Governor was speaking hours after US Federal Reserve Chief Janet Yellen decided not to hike interest rates, coming as a relief to economies like India that have seen stock markets rallying as a response to Fed's decision. Plus, ten days from now the RBI has to take a call on whether or not to cut interest rates at a time when inflation in India has touched historic lows and pressure is mounting from all sides to deliver a rate cut to boost growth.
 
Despite his assertion not to draw any veiled inferences from the contents of today's speech, he did give three useful insights into why he thinks low interest rates alone cannot spur the growth of any economy. And why he believes sustainable growth needs a lot more that just low rates and giveaways for the industry.
 
For one - he says, reforms (and not rates) hold the key to India's sustainable growth. "We have to expand the sustainable growth potential. That means continuing to implement reforms that government and regulators have announced that is the only way to get sustainable growth potential up," he said. A crystal clear message to the government - walk the talk, implement the reforms.
 
His second assertion was to learn from the experience of Brazil - an economy that was delivering an impressive 7 per cent plus growth rate just a few years ago and is now likely to shrink over 3 per cent. He says Brazil's central bank was "pressed to lower rates" fueling a credit spree that now overburdened customers are struggling to pay.
 
Third, the Governor today made a key distinction between the interests of the "vocal borrower" and the "silent saver." So while low interest rates benefit borrowers - be it individuals or the industry, we forget that they hurt the depositors. The Governor felt it was important to keep the silent saver in mind while taking a call on rates.

"For us at RBI, key task is to keep inflation low - not just today, but well into the future so that we get nominal modest rates that satisfy not just the very vocal borrowers but also the silent saver," he said.
 
Many of his critics will strongly disagree with his views arguing that if historically low inflation rates don't merit a rate cut, then what does? Shouldn't we be worrying about "deflation" rather than "inflation" as the Chief Economic Adviser Arvind Subramanian so clearly articulated recently.
 
But Dr Rajan's message is clear - he isn't succumbing to any pressures and will lower rates only when he feels the timing is right.
 
What's true is that Dr Rajan can be credited with putting India on a much stronger footing in his two years of Governorship. The Fed decided against a rate hike, but today India was far better prepared and a much stronger economy to deal with any global shocks than it was two years ago when he took over as the RBI Governor. In 2013, the taper tantrum sent Indian markets and the rupee into a tizzy putting us among the worst performing markets worldwide. Today, as Dr Rajan himself says - "India is an island of calm in an ocean of turmoil."
 
Dr Rajan, we're not taking any hints from today's speech. But for those who are taking a September rate cut for granted, be prepared for some surprises.