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Rajan Warns of Policy Breakdown as Emerging Markets Fall

By Kartik Goyal
January 31, 2014 7:32 AM EST 32 Comments
The rupee’s rebound from its Aug. 28 low helped pare the currency’s 2013 decline to 11 percent.
Photographer: Dhiraj Singh/Bloomberg
The rupee’s rebound from its Aug. 28 low helped pare the currency’s 2013 decline to 11 percent.

India central bank Governor Raghuram Rajan warned of a breakdown in global policy coordination after the Federal Reserve further cut stimulus, weakening emerging-market currencies from the rupee to the Turkish lira.

Rajan, a former chief economist at the International Monetary Fund, called for greater cooperation among policy makers weeks before finance chiefs from the world’s top developed and emerging markets gather in Sydney. The Fed’s Jan. 29 statement made no mention of developing economies.

“International monetary cooperation has broken down,” Rajan, 50, said yesterday in an interview in Mumbai with Bloomberg TV India, noting how emerging markets helped pull the global economy out of crisis starting in late 2008. “Industrial countries have to play a part in restoring that, and they can’t at this point wash their hands off and say we’ll do what we need to and you do the adjustment.”

Rajan raised interest rates this week along with central bankers from Turkey to South Africa as the Fed pressed on with a reduction in monthly bond purchases put in place to speed a recovery from the worst recession since the Great Depression. Emerging-market stocks have had the worst start to a year since 2008 as currencies from Argentina to Russia tumbled.

“The U.S. should worry about the effects of its polices on the rest of the world,” Rajan told a group of students in Mumbai today in response to a question on how Indian policies affect other countries. “We would like to live in a world where countries take into account the effect of their policies on other countries and do what is right, broadly, rather than what is just right given the circumstances of that country.”

Left Twisting

The rupee, down about 15 percent against the dollar in the past year, fell 0.1 percent today at the close in Mumbai.

The Fed said it will cut monthly bond purchases by $10 billion to $65 billion, citing improved labor-market indicators and accelerating economic growth. The move left emerging markets to “twist in the wind,” Steven Englander, the head of currency trading for major industrialized nations at Citigroup Inc., the world’s second-biggest currency trader, said in a note.

“Fortunately the IMF has stopped giving this as its mantra, but you hear from the industrial countries: We’ll do what we have to do, the markets will adjust and you can decide what you want to do,” Rajan said in the interview. “We need better cooperation and unfortunately that’s not been forthcoming so far.”

Bernanke Policies

Fed spokesman David Skidmore declined to comment.

Fed officials including Chairman Ben S. Bernanke have said their congressional mandate is to promote price stability and full employment in the U.S., goals that will ultimately benefit other developing economies.

“What we’re trying to do with our monetary policy here -- as I think my colleagues in the emerging markets recognize -- is trying to create a stronger U.S. economy,” Bernanke said in a Sept. 18 press conference. “And a stronger U.S. economy is one of the most important things that could happen to help the economies of emerging markets.”

Fed Governor Jerome Powell said in a Nov. 4 speech that policy makers in developed economies should “communicate as clearly as possible about their policy aims and intentions in order to limit the odds of policy surprises and a consequent sharp adjustment in financial markets.”

“My colleagues on the FOMC and I are committed to just such an approach,” Powell said, referring to the Federal Open Market Committee.

Fed Blame

The Fed shouldn’t be blamed for turmoil in emerging markets, former Fed Governor Randall Kroszner, a professor at the University of Chicago where Rajan once lectured, said on Bloomberg Radio’s “The Hays Advantage.”

“Countries that are being hit tend to be ones that have high current-account deficits, high fiscal deficits and relatively high inflation, and the challenge is brought on by their own domestic policies,” Kroszner said. “It’s unfair to say it’s all the Fed’s fault.”

The exit from monetary stimulus is “unsynchronized this time around,” Brazil central bank President Alexandre Tombini told a panel at the World Economic Forum meetings in Davos on Jan. 24. Tudor Investment Corp., the $13.7 billion macro hedge-fund firm run by Paul Tudor Jones, said earlier this month that global central bank policies will diverge this year for the first time since 2010.

Spillover Effects

In 2011, Rajan co-authored a report that called for the creation of an International Monetary Policy Committee composed of representatives from major central banks that would regularly report on the aggregate consequences of individual central bank policies. Central banks from bigger countries should be encouraged to internalize the spillover effects of their policies, it said.

Rajan said yesterday developed countries might not like adjustments emerging markets take to cope with the outflows, without elaborating on specific measures. His surprise Jan. 28 move to raise the benchmark repurchase rate by a quarter point - - adding to increases of 50 basis points since he took over the Reserve Bank of India in September -- was to stem consumer-price inflation running at close to 10 percent, he said.

“In an environment when there is external turmoil, we have to get our house in order and we can’t postpone that,” Rajan said. “So a collateral benefit of getting inflation down is that you also strengthen the belief in the value of the rupee.”

‘Extreme Volatility’

Rajan said the rupee has become “a little more stable,” and he’s intent on preventing “extreme volatility.” The rupee has strengthened 9.6 percent against the dollar from a record-low reached Aug. 28, the world’s best performer in that time, according to data compiled by Bloomberg.

“We may see some outflows, but I’m not overly worried at this point that it would be problematic,” Rajan said.

The RBI estimates consumer-price inflation will exceed 9 percent in the three months ending March 31, and range between 7.5 percent and 8.5 percent in the same period next year. A central bank committee led by Deputy Governor Urjit Patel last week suggested reducing CPI to 8 percent within one year and 6 percent by 2016, at which point it would adopt a 4 percent target with a band of plus or minus two percentage points.

“Ultimately if we go towards some kind of a medium-term inflation target, like the Urjit Patel committee report has suggested, it would be good for that target to have the support of the parliament, support of the government,” Rajan said. “Since our mandate is bringing down inflation, the fact that we pick a number is not in any way inconsistent with our mandate.”

‘Same Page’

Finance Minister Palaniappan Chidambaram challenged the central bank’s proposal of prioritizing inflation over growth in an interview last week and called the inflation target “ambitious.” Rajan said the government will follow through on promises of fiscal tightening.

“When there is huge outside turmoil, even today post the Federal Reserve withdrawing stimulus further, it is extremely important that we both be seen on the same page,” Rajan said. “There is a huge degree of understanding and communication between the government and the central bank.”

India’s current-account deficit will narrow to below $50 billion in the financial year ending March 31 from a record $88 billion in the previous 12 months, Chidambaram said in a statement yesterday. The fiscal deficit will contract to below 4.8 percent of gross domestic product in that time, a six-year low, Economic Affairs Secretary Arvind Mayaram told reporters yesterday.

‘Complete Nonsense’

“I don’t think there should be major impact on us,” Mayaram told reporters in New Delhi when asked about the impact of the Fed’s decision. “There should not be undue worry.”

Asia’s third-biggest economy can grow between 5 percent and 6 percent in the next fiscal year ending March 2015 if inflation slows, the RBI said this week. GDP will expand “a little below” 5 percent in the year through March 31, it said.

Rajan disputed criticism that lower interest rates would lead to higher growth because banks are fixing interest rates based on inflation.

“This notion somehow that the RBI is standing in the way of growth is complete nonsense,” Rajan said. “Today what is standing in the way of growth is inflation. Unless we bring inflation down, growth with lower interest rates has no hope.”

To contact the reporter on this story: Kartik Goyal in Mumbai at kgoyal@bloomberg.net

To contact the editor responsible for this story: Daniel Ten Kate at dtenkate@bloomberg.net

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