India: Rajan steadies the ship

Central bank chief Raghuram Rajan has put India's recovery back on track.

Raghuram Rajan, governor of the Reserve Bank of India (RBI), raised the country's benchmark interest rate by 0.25% to 7.75% this week. It was the central bank's second hike since Rajan, a former chief economist at the International Monetary Fund (IMF) credited with predicting the 2008 crisis, arrived last month.

The rupee has gained 12% against the dollar since its record low sparked concern that a currency crisis would overcome the economy.

What the commentators said

That's because his interest-rate hikes lift potential returns on Indian assets higher, thus bolstering the currency, and show he's serious about tackling inflation.

Consumer prices have been rising at an annual rate of 8% over the past few years, noted Abheek Bhattacharya in The Wall Street Journal. Pre-Rajan, the RBI "didn't respond strongly enough".

Short-term borrowing costs have been negative in real terms for most of the past five years. And it hardly helped matters that negative real interest rates were deterring the foreign capital needed to plug the current account deficit, which ballooned to 4.9% in the second quarter.

The external deficit is now coming down amid repeated increases in duties on gold imports. These in turn will dwindle further as deposit rates for cash turn positive in inflation-adjusted terms.

While Rajan is concentrating on inflation, dearer money will temper growth, which the IMF now reckons could fall to 3.8% in the year to April 2014. This is where he needs help from the government, said Leif Eskesen of HSBC.

The government has been spending too much, and been too slow to deregulate the economy to encourage investment. Rajan has steadied the ship, but the government must get its act together if the recovery is to last.

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