The Legacy: Raghuram Rajan is leaving the battlefield just when he was getting the better of his rivals

India’s debonair central banker, Raghuram Rajan, leaves behind many broken hearts and disappointed souls. Chronicles of his legacy will list many achievements, but will also note that he left the battlefield just when he was getting the better of his rivals; what’s surprising is that the commander-in-chief agreed to his pre-mature withdrawal even though the general’s strategies could be seen bearing fruit.

Equally perplexing will be the choice of his replacement.

Both the government and Rajan personally have been advocates of an alternative global financial architecture. He has also been proposing for a while that it was time for a new Bretton Woods mechanism. And Rajan had taken the battle to the enemy camp. At the April 2016 spring meetings of the International Monetary Fund and the World Bank, Rajan observed how deeply multilateral financial institutions were in thrall of western economic orthodoxies. He even wryly remarked how ideas from emerging economies were dismissed as “crankiness.”

He was prescient about the trans-Atlantic financial crisis. He took on former US Federal Reserve chairman Ben Bernanke when US domestic monetary policy spilled over into the global economy and led to severe volatility in emerging markets. He is unlikely to have fond memories of the period: he had to douse this particular fire soon after his appointment in Sept. 2013.

So, here is question number one: Will his successor have the same zeal about promoting an alternative global financial architecture that is sensitive to emerging economy needs and is not partisan about any particular economic ideology?

Rajan also quits before another crusade could be brought to its logical end. He’s been battening down the hatches that allowed a cosy nexus between large corporate borrowers, bankers, politicians, and bureaucrats, to bleed public sector banks through questionable debt write-offs. Rajan had taken a large broom to bank balance sheets and forced them to take drastic action against defaulters.

Many large—and over-stretched—corporate borrowers have been carping about Rajan’s reluctance to reduce interest rates, which, when lowered, would have certainly helped moderate their interest burden. These same corporates also turned into quack economists on the matter of interest rates: in their collective view, only lower interest rates could bring back high rates of economic growth. This view is oblivious to the fact that the low interest rates in the US, or negative rates in Europe and Japan, have failed to promote any economic growth.

Time for question number two: Will Rajan’s successor have the stomach (or benign sanction from the government) to continue with the clean-up act? Or to hold rates steady when required?

So, what does Rajan’s legacy look like? Apart from the well-documented success in fending off volatility from the US Fed’s tapering in 2013, his tenure will be remembered for three systemic changes he fostered.

One will be the differentiated banking landscape that he designed and left behind. As RBI governor, he grandfathered the emergence of a new breed of universal, small, and payments banks. He was in the process of adding two more categories—custodian banks and wholesale (or long-term) financing banks—to the mix. We will now have to wait and see if his successor has the same enthusiasm for a differentiated banking model.

These new categories come in addition to existing myriad forms of cooperative banks, regional rural banks, local area banks, public sector scheduled commercial banks, State Bank of India group of scheduled commercial banks, old-generation private sector banks, new-generation private sector banks, and foreign banks.

Restive signs mark the payments banks space—three companies which received in-principle approval to launch payments banks (Cholamandalam, Tech Mahindra, and Dilip Shanghvi of Sun Pharma) returned their licences stating that the project was not economically feasible. Undeniably, and in true RBI style, the initial architecture is anti-profit and has flaws in it.

The second marquee item is his strict action against non-performing assets (NPAs) that continue to impair bank balance-sheets. This was viewed as his struggle to end Indian-style crony capitalism: large volumes of loans remain unpaid every year and yet defaulting borrowers manage to get fresh loans unfailingly with some help from politicians, bureaucrats, and complicit bankers.

The staggering amount of NPAs is a direct drain on taxpayers, since loss to state-owned bank balance sheets must be compensated with fresh equity infusion by the largest shareholder—government— every year.

Finally, the outgoing governor will be remembered for installing a new monetary policy framework, which uses inflation-targeting as its driving philosophy. It also includes a monetary policy committee comprising three government representatives and three central bankers, with the RBI governor getting the casting vote. This new structure overhauls the old belief that the economy’s fiscal (the government) and monetary policy (central bank) sides should remain out of each other’s hair.

While the government has been uncomfortable with Rajan’s public comments about governance and broader political economy trends—saying that central bankers should not interfere with the fiscal side—it has not shown the same restraint when trying to influence monetary policy.

It will have to be seen how future central bankers and monetary historians view Rajan’s acquiescence to large government presence in monetary policy making.

The article first appeared in www.qz.com/india and can also be read here.

New Concepts For BRICS

At a recent international seminar on BRICS Studies, in addition to the predictable themes such as building a multipolar world order and the One Belt One Road project, fresh ground was also covered, including the contours of the New Development Bank and the potential impact of the refugee crisis on BRICS countries.

The focus of the conference was to deliberate and discover new development paradigms that are markedly different from the Bretton Woods doctrine, and how BRICS members can embed these in practice.

The opening day included numerous speeches, mostly by former Chinese ministers and diplomats. The overall thrust was predictable: the Bretton Woods’ ideological unipolarity has to end, a new development canon has to be developed, China is interested in fostering a new multipolar world order along with other BRICS countries (as well as other developing and emerging economies), and the world’s (especially western economies’) mistaken notions of China’s global ambitions need to be corrected urgently.

Another recurring theme was bewilderment at India’s inexplicable reluctance to partner in the One Belt One Road initiative.

One of the notable keynote speakers, Leslie Maasdorp, vice president, BRICS New Development Bank (NDB), made three critical points: the NDB will be driven by pragmatism and all changes to the existing paradigm of development financing will be gradual; the Bank will embrace innovation and unlock new technologies with help from civil society and young graduates; and it was working with a long-term horizon of 25-30 years.

Maasdorp also sought to allay three popular misconceptions—that the NDB will compete with the World Bank and the International Monetary Fund, that it will be dominated by China, and that its governance structures will be lax.

Among all the interjections, three stood out. In light of the refugee influx into Europe, BRICS members were requested to also frame a policy on migration. BRICS cannot remain insulated from this humanitarian issue, especially when the growth rate of some members is higher than that of their neighbouring countries. Second, if China wants to partner with BRICS and other emerging economies in articulating a new development theology, it will have to address internal social infirmities such as restrictive human rights, the bar on freedom of speech, and lax safety standards at its industrial complexes. Finally, China was advised to retrospect about why it was misunderstood by other countries, especially India, and make the necessary course corrections.

The seminar, titled ‘New Thinking on Development and BRICS Cooperation’, was organised by the Center for BRICS Studies at Fudan University, Shanghai, on 4-5 September 2015. The text of the full paper follows this blog post. 

The paper was originally published in Gateway House. Here is the link to my paper at the conference: http://www.gatewayhouse.in/wp-content/uploads/2015/10/Rishi_Fudan-full-report.pdf

When Harry Met Keynes

The financial crisis of 2007-08 has sparked a renewed interest in the Bretton Woods compact, which created a "prosperous" world for about 20-30 years. Academics across the world have been wondering whether the world needs a new agreement and new institutions to meet the demands of a new economic order. The perception is that the 44-nation Bretton Woods discussions, which gave birth to the multilateral institutions World Bank and the International Monetary Fund, were held in a generally conducive and collegial atmosphere. This is not true. A new book on the Bretton Woods discussions -- The Battle of Bretton Woods by Benn Steil --  shows how the talks were held in a generally combative atmosphere.

My review of the book was carried by Business Standard (http://goo.gl/s758Q). Here it is:

In a rare photo op, the heads of the World Bank and the United Nations flew to violence-scarred East Africa recently. There was nothing spectacular about this visit - it showcased two ageing international bureaucrats posing together and providing sound bites about how their respective institutions were willing to work together to bring peace to this war-ravaged region, also known as the Great Lakes region. It could well be a convergence of coincidences: both dignitaries happened to be there at the right time, and both were born in Korea.

But there was another bit of detail that made this visit interesting and historic: this was probably the first time these two multilateral institutions were actually seen working together and promising to enhance this co-operation in future. Though they had made similar noises in the past, they unfailingly broke their promises. Both institutions, with unwieldy and terribly insular bureaucracies, have been distrustful of each other.

The genesis of this strife and suspicion towards each other can be found in the circumstances surrounding the birth of the World Bank along with its sister institution, the International Monetary Fund (IMF). Both these multilateral agencies were the outcome of a post-Depression meeting comprising 44 nations in a small New Hampshire town called Bretton Woods. The meeting, which was held in Mount Washington Hotel, was aimed at creating a lasting post-war global economic compact - an agreement that would lay down the long-term blueprint for global economic prosperity.

In reality, the conclave turned out to be a contest between two powers: the United Kingdom, a waning imperial power keen to reverse its ebbing national self-esteem; and the United States of America, the global superpower eager to leave its imprint on the global economy.

At first sight, the dice seemed loaded in favour of the UK team, which included the first celebrity economist of modern times, John Maynard Keynes. His formidable reputation, his distaste for intellectual lightweights, his irascible temper, and his sharp tongue gave the British side a psychological advantage. Keynes had been planning to create an international currency union, which would launch its own international currency - "bancor", an alternative to the all-powerful dollar - and lend to indebted countries such as Britain.

But the American side had a surprise: Harry Dexter White, a dogged and industrious bureaucrat who enjoyed the confidence of Henry Morgenthau Jr, then Treasury secretary. White, a Harvard-trained economist, had been hatching a plan to create an international stabilisation fund. This fund would not only lend dollars to debtor countries, but also stabilise currency movements across the world by convincing countries to peg their currencies to the dollar and, in turn, peg the dollar to a fixed gold price.

When Keynes' and White's plans collided at Bretton Woods, the result was the birth of the IMF. History shows that the discussions took place in a collegial atmosphere, but author Benn Steil's latest version injects an undercurrent of understated hostility, marked by a sparring match between two monumental intellects, and egos.

Differences even crept up as to where to locate the IMF - Keynes felt New York (in close proximity to the UN's Economic and Social Council) was ideal, but his suggestion was railroaded by the US' preference for Washington, DC. The dividing lines were also quite pronounced about the IMF's future role.

A book that describes in detail such a conference, its leading characters, and changing moods and directions is usually as dull as dishwater. There are quotes from agendas, memos, official correspondence, file notings, research papers and personal letters. What saves the day, or adds colour, is the insight into the character of White, whose personal papers were made public only recently. He was believed to be a Russian spy and was accused of passing on the details of the Treasury department's plans and former US president Franklin Roosevelt's thoughts to his contacts in the Russian embassy. Mr Steil has refrained, sensibly, from dwelling too much on Keynes' homosexuality and its presumed impact on policy making, as some right-wing historians have tried vainly in the past.

The book's over-reliance on minutiae can be crushing, but given the renewed interest in economic history - especially the Great Depression and the creation of the Bretton Woods institutions - Benn Steil cannot be faulted for his timing.

THE BATTLE OF BRETTON WOODS
John Maynard Keynes, Harry Dexter White, and the Making of a New World Order
Benn Steil
Princeton University Press
449 pages; $29.95

New Bretton Woods Or Globocops?

A new multilateral regulatory structure seems unlikely now, given that the Fed and some central banks would not like to be told what to do. But, there is bound to be greater global coordination between central banks

A FEW days ago, the US Federal Reserve opened swap lines of $120 billion with four countries — Brazil, Mexico, Singapore and South Korea — to keep international liquidity pipelines unclogged. A few days before that, the European Central Bank entered into foreign currency swaps with Iceland and Switzerland, even though they are not part of the Eurozone. A $12-billion swap line was also established with Denmark. ECB also offered Hungary a $6.4-billion loan to tide over its temporary liquidity shortage. The objective of these swap lines is the same — to ensure that the global financial system, especially the countries that are “systemically” important to the US and European economies, do not suffer from a temporary shortage of dollars or euros, leading to a further deepening of the global credit crisis.

Traditionally, this job should have gone to the International Monetary Fund. Conspiracy theory proponents will undoubtedly detect a dishonourable political design here — with developing countries demanding a more egalitarian shareholding structure in the multilateral institute, this is the only way in which both the US and Europe can maintain their sway over the global financial system. But, such extreme hypotheses apart, the IMF normally takes some time to design restructuring packages for distressed economies, while the Fed and ECB are more concerned with overnight and short-term liquidity issues. Plus, here’s the biggest difference — central banks can print money, while IMF has to depend on shareholders’ largesse. So, given the severity of the global financial crisis, both the Fed and the ECB are not leaving anything to chance, or to the IMF’s time-consuming methods.

They are now stepping into a role that is not specified in their mandate. For instance, ECB’s twin-edged mandate is to maintain price stability in the euro command area and to support the general economic policies of the European Community. The Fed’s conventional role, on the other hand, was to ensure full employment, but the oil shock of the 1970s saw US lawmakers adding inflation combat to that traditional mandate. With the current global financial blowout, both the Fed and ECB are now trying to broaden their usual role into some form of “global lenders of last resort”. They are now ready to provide liquidity to liquidity-starved nations in exchange for marketable and non-marketable instruments, even though such paper may be below the normally accepted credit-rating threshold.

This marks a sharp change from the way these central banks have operated over the years and may even provide some clues about how they will conduct their business in the future. The question that arises immediately, therefore, is: are central banks world-over going to morph into something different?

One thing is definite: henceforth, the Fed is sure to get responsibility for ensuring “stability in the financial system”. The Fed’s hands-off policy with regard to Wall Street and its high jinks has not gone down well with millions of US taxpayers who feel burdened with the responsibility of having to bail out errant banks and financial institutions. Academic and quasi-academic literature over the past few weeks is full of references to how central banks must now build efficient radar systems that can detect incipient trends of financial turmoil and head them off before they can grow in size. However, that’s easier said then done. Experts agree unanimously that it’s also very difficult to pinpoint asset-price bubbles early on in the game. Yet, the political impact of the recent experiences is likely to see lawmakers foisting central banks with some accountability.

As a corollary, central banks the world over will now find it difficult to keep monetary policy and bank supervision separate. There are already rumblings that central banks should have oversight over all components of the financial system, especially when recent experiences have shown that it takes no time for the contagion to spread from one segment to the other.

At a recent conference in Chile, Sveriges Riksbank’s deputy governor Lars Nyberg said: “I want to emphasise that monetary policy is perhaps not the most efficient instrument for preventing crises from happening. Even though a too loose monetary policy may contribute to the build-up of a bubble, it is less clear to what extent monetary policy can prevent such a build-up. It is quite likely that substantial interest rate increases, that central banks would find it hard to implement, would be required to achieve this. More moderate rate increases may, of course, still have an effect at the margin, not least as a signal from the central bank that there are certain concerns linked to prevailing developments. But a more capable line of defence to prevent financial crises is to have proper rules and effective supervision in place.”

Transparency is another word that is likely to be heard with increasing frequency in coming months. The demand that central banks lift the veil from their operations is being heeded in degrees, some with a greater extent of openness than some others. And then there are some which operate in a completely secretive environment. Add to this the fact that most financial markets are still opaque and you have a lethal combo. The extreme opacity in the way financial markets created and traded financial instruments is a major reason behind the current crisis. In the days ahead, lawmakers are certain to demand a greater measure of transparency from both central banks (since many commentators have also blamed central banks’ easy money policy for the turmoil) and financial markets.

Finally, will there be new Bretton Woods institutions, responsible for global financial governance, or will central banks become the new globocops? A new multilateral regulatory, institutional structure seems unlikely now, given that some central banks — especially the Fed — would not like to be told what to do. But, there is bound to be greater global coordination and a higher volume of data exchange between central banks. For instance, jointly, both the RBI and Fed should now be able to wring more data out of financial institutions on the sources behind participatory notes.

Published as Op-Ed in The Economic Times (November 14, 2008)