The limits of star power

A picture of Raghuram Rajan So-called rock star central bank governor Raghuram Rajan faces a tough time ahead

Can a central bank governor prevent a crisis? The answer will matter not just to India and other emerging economies facing the looming end of the era of cheap money, but to all countries that have gone through a banking crisis and those worried about the impact of a crisis in an inter-connected world economy.

Expectations are high for India's new central bank governor, Raghuram Rajan, who has increased confidence so far, but it's a tough time for Asia's third largest economy.

With economic growth at the weakest pace in a decade at 5% and expected to slow further, the Indian central bank is in the unenviable position of having to raise rates to combat inflation.

When rates rise, borrowing is more expensive and it is harder for firms to invest and for households to manage their debt.


One of the reasons for a rate hike under these circumstances is to shore up the currency, the Indian rupee.

When rates are higher - they were raised for the second time in as many months by the new governor to 7.75% on Tuesday - there is a greater return for investors putting their money into India.

Start Quote

India is between a rock and a hard place: raising rates to combat inflation and support the currency, but it hurts growth”

End Quote

That helps to support the rupee that has hit record lows against the US dollar.

A weak currency contributes to higher inflation that squeezes people's livelihoods and could cause foreign firms to leave as the real returns to their investment would fall.

So, India is between a rock and a hard place: Raising rates to combat inflation and support the currency, but it hurts growth.


Yet, despite these challenges, the Indian stock market is near all-time highs and the rupee has moved away from where it was in September when it was the weakest on record against the US dollar. That was when it was headed toward 70 to the dollar. It is now closer to 60, which I wrote about in August.

The rupee was weaker than even during the 1991 balance of payments of crisis.

It was exacerbated by the Fed's talk of tapering its cheap cash injections, which has now receded due to the US government shutdown.

Mr Rajan, who took over in early September, has been credited with the "Rajan rally". The UK isn't the only country with a so-called rock star central bank governor.

Mr Rajan says that Japan's prime minister Shinzo Abe has three arrows in his economic policy dubbed Abenomics, but he has five pillars: Improving the monetary policy framework, reforming the banking system, liberalising markets, increasing financial inclusion, and sorting out financially distressed financial institutions.

The reforms of the banking system are particularly welcome, but notice there is a lot which isn't included and understandably so as it's beyond the remit of central banks. Mr Rajan's five pillars lack the deep, broad-ranging structural reforms that comprise the third arrow of Abenomics which will have the most lasting impact.


A central bank governor can do a lot these days. But, even a central banker as respected as Mr Rajan cannot address the lagging structural reforms that have affected India's development since independence in 1947.

For instance, India was richer than the other billion-plus population country in 1980, but now average incomes are a quarter of that of China. It was only in the past five years that India's GDP per capita exceeded $1,000, the level that demarcates the poorest countries in the world.

And, the absolute number of people who live in poverty has risen since 1980 and about one-third of the population live in abject poverty of less than $1.25 per day, while nearly 70% live on less than $2 per day.

Average incomes have also barely risen in the past couple of years and only sped up with growth accelerated in the 2000s to 8-10% and that's when it exceeded the $1,000 GDP per capita threshold. In other words, growing at less than 5% isn't fast enough to significantly raise average incomes, which matters - especially for a growing population.

Coming back to why India has lagged. One reason is the challenge of industrialisation. Manufacturing can propel countries to grow quickly as they move out of agriculture and produce higher value-added products before eventually becoming more of a services economy like the UK and the US did after the Industrial Revolution.


India rather unusually has a larger services sector than industry at this stage of development. Services account for nearly 60% of GDP while industry is about a quarter which hasn't increased by much in the past few decades.

As China was industrialised in 1980, rather forcefully during the centrally planned period, it is one of the explanations for the difference in growth rates.

Services can generate economic growth, but not as much as industrialisation which is based on technology that can drive fast growth.

It was what generated the strong growth rates seen in other countries in Asia that have industrialised, and in the West during the Industrial Revolution that exponentially increased incomes.

So, the question is why hasn't India industrialised? There isn't one answer as there have certainly been attempts, such as when India attempted to boost manufacturing through protecting its firms from competition from abroad. Import substitution industrialisation (known as ISI) didn't work very well, unlike in Latin America during the 1950s and 1960s.

Start Quote

India has to be seen as an attractive market for banks to enter”

End Quote

Some factors haven't helped. A key issue is education. Even today, only 63% of secondary school-aged children are enrolled in school, according to the World Bank. That falls to 16% for higher education. The average number of years in education is just five years, which places India below the global average and is less than half of that for developed economies.

Education enrolment has improved in recent years, especially at the primary school level. This is, though, an issue that lies beyond what a central bank governor can do.


The other factor is a lack of bank financing, which has shepherded entrepreneurs into services rather than production. Starting a services company doesn't require a loan for machinery, for instance. And this is an area where the central bank can do something to help. It's one of Mr Rajan's five pillars. By opening up the banking system to competition, including foreign banks, he aims to increase credit that can help people start businesses.

It'll take more than the central bank relaxing regulation though. India has to be seen as an attractive market for banks to enter. Still, it's a step in the right direction.

But, the other parts of support that is needed for industrialisation, such as roads, telecommunications infrastructure, and a welcoming regulatory environment, will be largely out of the hands of the central bank governor.

Those structural reforms will be important to address the "twin deficits" that have caused the rupee to plunge and for many to worry about a repeat of the 1991 crisis.

Only by producing more can India close its sizeable current account deficit, which is the widest measure of the trade gap including investment flows. The second deficit is the budget which is in the hands of the government. Both are around 4-5% of GDP - which are worrying levels. The central bank supporting the currency is only a temporary bandage.

The central bank governor can't sort out the trade deficit, the fiscal deficit or the lagging education system. These are among the persistent issues that have plagued India's growth.

But, a central bank governor can inspire confidence that he can manage financial stability and has the tools to address a potential crisis.

So far, it looks like Mr Rajan has done a lot in just two months. But, can he prevent a crisis? And will the Rajan rally last? Find out tomorrow when I check out the star power of India's new central banker when I interview him in Mumbai.

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

Britain - a nation of online shopkeepers?

We may soon find out if Britain's traditional retailers are feeling the pinch over the holiday season, as more customers shop online.

Read full article

More on This Story

More from Linda


This entry is now closed for comments

Jump to comments pagination
  • rate this

    Comment number 22.

    Sorry, comment 21 is a response of comment 17.

  • rate this

    Comment number 21.

    In response to the comment 14, yes it is 100% true; we need much more political & economic autonomy for the states. Centre should act like a watchdog and to monitor how the state funds are utilised for the benefit of the people belongs to that state.

  • rate this

    Comment number 20.

    A central bank governor who believes in sound money!

    That’s a rarity, these days.

  • rate this

    Comment number 19.

    In response to the comment 14, poverty in India can’t be compared with London or Britain. One is ruler while the other was ruled. British rulers were there not for charity, history knows what happened with our gold, diamond, manpower (slavery) and BLOOD. East India Company went there for business, but soon after the face of an investor turned into an invader and exploitation begins.

  • rate this

    Comment number 18.

    but today it is being mismanaged due to our present rulers (politicians) and bureaucrats. And above all corruption. If we can curb corruption with better governance and utilise our resource through direct involvement of our people, I don’t think RBI need to struggle to revive the economy of a country which have lots of potentiality.

  • rate this

    Comment number 17.

    To alleviate poverty in India, governance must be really decentralized with will and wisdom. Every state in India should have their own currency.

  • rate this

    Comment number 16.

    Population is an issue but that’s not everything. Because when British left India in 1947, on that time population was 330 million but if we see the economic situation on that time it was awful. Today there is no famine but there is malnutrition I agreed. Before 1947 our resources were used by British rulers for their benefit, but today

  • rate this

    Comment number 15.

    Which GDP composition is better?

    Industry 21.1% Services 78.2% (UK)
    Industry 28.1% Services 71.1% (Germany)

  • rate this

    Comment number 14.

    That's why they're buying up Gold. They are so used to economic crisis, and indeed, terrible poverty.
    Living conditions for many people there are far worse than 19th century London. No trickle down yet.
    Mobile telephones are surprisingly popular though.

  • rate this

    Comment number 13.

    Can he prevent a population crisis in India as that is the route cause of many of their issues.

  • rate this

    Comment number 12.

    "So the question is, why hasn;t India industrialised?"
    One common answer you get if you ask manufacturers why they haven't set up shop in India is the tedious, disjointed and bloated levels of bureaucracy associated with the country. Another is the poor levels of supply and distribution channels.

  • rate this

    Comment number 11.

    Politicians, bureaucrats’ mind-set/arrogance should change; they should know they are there to serve people & make things simpler.Currently anything to do with govt isvery complicated, too muchof red tapes to get simple something done unless u pay bribe.The Indian govt should study, employ best people from around the world and introduce policies /best practises that work well in other countries.

  • rate this

    Comment number 10.

    "the looming end to cheap money" interesting!

  • rate this

    Comment number 9.

    Obviously these star performers need a good manager.

    I propose that Osborne be sent out to advise on how towels should be folded.

  • rate this

    Comment number 8.

    Anyone that has tried to do business in China and India will have noticed that it's much easier to do business in China. The rules, regulations and general ways of doing business in India are so complex that it comes across as not really wanting to do business. China is so much easier.

  • rate this

    Comment number 7.

    "Can a central bank governor prevent a crisis?" - Yes !

    He can resign and advise the government to disband the central bank and abolish it's monopoly of money production.

    Apart from that, everything he does is to try and mitigate the detrimental effects of the interventions he made previously.

    Like all politicians, they're best not doing anything. All they can do is mess things up for us all.

  • rate this

    Comment number 6.

    Mr Rajan has an uphill battle to save the rupee and US shutdown has helped!
    Priorities must be to finance new companies, and to educate and include women
    Pariah is a word derived from S India, Mr Rajan must try to include all Indians in a continent wide change of attitudes.

  • rate this

    Comment number 5.


    "Can a central bank governor prevent a crisis? "

    In a word NO - all the BofE can do is adjust monetary policy.... needs the Govt. to make changes to Fiscal policy....

    ....& no national economy runs for any length of time on either monetary or fiscal policy alone....


  • rate this

    Comment number 4.

    As in US, Indian economics is governed by fiscal and monetary policy. Governor of RBI can only influence monetary policy. The Prime Minister of India can only influence the fiscal policy. The national elections in India is in 2014, which shall decide the next PM. So, any growth can happen only after 2014 irrespective of RBI actions. RBI can only arrest inflation until the growth commences again.

  • rate this

    Comment number 3.

    It's not a galactico signing that India needs-it needs to get rid of the needless bureaucracy and corruption that exists at every level of Society. It is driving away businesses at the rate of knots. Needs to embrace controlled free markets, and let the natural talents of its People flourish rather than stifle them. It seems to start with the belief: The answer is "No" now what is the question?


Page 2 of 3



BBC © 2014 The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.