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Indian central bank chief on the wake-up call to reduce foreign money dependence

December 25, 2013 at 12:00 AM EDT
India has one of the world's largest economies, but growth for the advancing country has slowed to less than 5 percent a year since 2011. With the value of the rupee dropping and inflation surging, how is India's central bank prepared to cope? Hari Sreenivasan interviews Raghuran Rajan, governor of the Reserve Bank of India.
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GWEN IFILL: Now to South Asia and the man behind efforts to restart a once-surging economic powerhouse.

Hari Sreenivasan reports.

HARI SREENIVASAN: It’s been a tough year for one of the world’s largest economies, India, a member of the advancing BRIC countries, along with Brazil, Russia and China, is struggling to keep its reputation a growing economic power. But growth has slowed to less than 5 percent a year since 2011.

The rupee has lost more than 11 percent of its value this year, and inflation surged above 11 percent in November, with sharply higher prices for vegetables and other foods, making life especially hard on the poor.

MAN (through interpreter): Today, it is impossible to spend a day on just five rupees. It was perhaps possible 50 years back. Today, five rupees don’t fetch anything.

HARI SREENIVASAN: The faltering economy shapes up as an issue in next year’s national elections. In the meantime, the Reserve Bank of India, the country’s central bank, is trying to cope.

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Raghuram Rajan became governor of the Reserve Bank in September and has boosted borrowing costs twice since then.

BEN BERNANKE, Federal Reserve Chairman: The committee decided started next month…

HARI SREENIVASAN: Then, last week, the U.S. Federal Reserve announced it will begin to wind down its economic stimulus program. Expectations of the movement already helped drive the rupee lower.

But Rajan his country is better prepared to cope now than it was a year ago.

I spoke with him this week in Mumbai to get his take on what lies ahead for the Indian economy.

Help a U.S. audience member understand how our two economies are connected. When the Fed chairman this summer announced that we would begin tapering, it contributed to the rupee declining in value against the dollar to new record lows. So how does what happens in the Fed affect the Indian economy?

RAGHURAM RAJAN, Reserve Bank of India: Well, we have had a number of years of very low interest rates in the United States.

What happens is then money looks for new places to invest in. And a lot of money has come looking for returns to places like India. Fortunately for us, a lot of money that has come in from overseas has been into equity markets, rather than into debt markets. But we also got some money into Indian debt.

So, when the Fed says it’s going to raise interest rates, what happens is, people say, aha, now the interest rate differential is not so attractive. Maybe I will bring my money back and put it in U.S. debt, which didn’t pay high interest rates so far.

And so we get a reversal of flows. That reversal of flows mean that they sell rupees by dollars, and the rupee exchange rate plummets, but, basically, it was a wakeup call to us to not be as dependent on foreign money as we were.

Put differently, we can’t, you know, buy as much foreign goods as we were, produce more locally.

HARI SREENIVASAN: A few years ago, there was this notion that the developing countries were going to be this new engine. And now you see the BRIC countries, Brazil, Russia, India, China kind of slowing down a bit. India is growing at half the rate it was a couple of years ago. Are we waiting for larger economies to become the power, sort of the steam engine again, or can India rebound on its own?

RAGHURAM RAJAN: Well, I think everyone is looking for a new model of growth.

And I think India is going to discover that model over time. And — and that model requires doing things a little differently, more investment, less consumption, more effective implementation of large products. I have no doubt that Indian growth will pick up from 5 percent, where it is now, is not bad. It’s bad relative to the 10 percent it was growing at in some years in the past.

But going back to higher rates of growth, I think once it figures out how to do things more cleanly and better, I think it will resume that level of growth.

HARI SREENIVASAN: So, a few months ago, there was this meme in the Indian press about the price of onions and how they had doubled and in some places tripled. Now the price of vegetables in markets have come down for several reasons, but, really, the bigger question is about inflation.

Consumer inflation in India is 11 percent and almost 11.25 percent this month. How does the central bank address that, especially when the poor feel inflation on food and fuel prices disproportionately hard?

RAGHURAM RAJAN: Absolutely.

I think it’s a important challenge. I think, as you said, vegetable prices have come down. There’s a spike. They have come down substantially since then. So, we should see some of that inflation fall off. But whether it’s 9 or whether it’s 11, it’s still too high. We need to bring it down.

Some of it has to be done by addressing the supply constraints in the economy. That will happen over time. But we have to also ensure that, from the central bank’s perspective, we send a clear signal that higher rates of inflation will not be tolerated.

I think you have to bring both sides together to get inflation down to healthy levels.

HARI SREENIVASAN: Help us understand the balance between growth and inflation. Right? On the — there are estimates that about a million new Indians will enter the work force — or, I should say, be of working age every month for the next 10 years.

So how does the central bank create an environment where you can actually create jobs for all those people without contributing to inflation?

RAGHURAM RAJAN: Well, the first thing is, we don’t directly have an effect on growth, other than through maintaining inflation relatively low.

Over the long term, these tradeoffs are — basically disappear. And, essentially, the best way we can keep growth going is by maintaining a low level of inflation. However, as a developing country central bank, we have additional tools to the ones that developed countries have. We can develop the system. We can ensure, for example, payments reach every part of India.

Remittances can be sent by a migrant laborer to his village back at very lost cost. That helps the village flourish, helps more reallocation of labor to places where they can be employed. That can help growth.

HARI SREENIVASAN: While you — you have said that you don’t pay attention to the election calendar, a lot of people around the world are looking at India and saying, there’s a very important election coming up.

How do you outcomes affect the Indian economy?

RAGHURAM RAJAN: Well, I think they’re important for the Indian economy.

I think there is a consensus behind reforms which will take us forward regardless of which political party comes into power. But I think, if — what we need is a stable coalition post-elections, because stable coalitions can make decisions more easily.

The — there’s a small possibility that the coalition that comes into power doesn’t contain one of the big political parties, in which case there may be a little more sort of difficulty in getting together on policies.

But we must remember that, you know, some of the best budgets in Indian history, from the perspective of growth, were presented at times of very fractured coalitions.

HARI SREENIVASAN: So, if the existing party doesn’t remain in power, does that mean that you tender your resignation?

RAGHURAM RAJAN: No.

Mine is a technocratic position. I’m not a political — I don’t owe allegiance to any political party. And, therefore, I don’t have to. I can — I think I can be removed, but I don’t have to tender my resignation.

HARI SREENIVASAN: All right, Raghuram Rajan, thanks so much for your time.

RAGHURAM RAJAN: Thank you.