Raghuram Rajan on Sunday was named central bank governor of 2014 by the editors of Central Banking journal. On Thursday, he demonstrated why.
Mr. Rajan jolted groggy traders awake by cutting the Reserve Bank of India's benchmark interest rate by a quarter-point to 7.75 per cent early in the Indian trading day. The decision was a bold one, coming more than two weeks ahead of the central bank's next scheduled policy meeting on Feb. 3. Local stock markets surged to their highest levels in eight months and the rupee jumped to its highest level against the U.S. dollar since the end of November.
"The cut comes as great news for the Modi government, whose principal economic policy objective has been to jump-start growth," said Vivek Dehejia, an economics professor at Carleton University who currently is based in Mumbai and studies the Indian central bank.
Policy makers think carefully about the timing of their announcements. Positive surprises can amplify the effects of a shift in policy. In this way, Mr. Rajan was doing his part in Prime Minister Narendra Modi's efforts to restore confidence in Asia's third-biggest economy. Mr. Modi in recent weeks had overcome opposition obstruction in parliament to implement controversial changes meant to boost investment, including an increase in foreign-ownership limits in the insurance industry to 49 per cent. At the same time, Finance Minister Arun Jaitley has pledged to meet the government's short-term deficit targets. Mr. Rajan's rate cut ensured monetary and fiscal policy are working in concert, a noteworthy development at a time when governments have been content to let their central banks do the heavy lifting.
But there is more to Mr. Rajan's rate cut than proving he is a team player. The timing is significant. Typically, when central banks make unplanned policy announcements there is a pressing reason to do so. Mr. Rajan faced no such pressure. In a statement, Mr. Rajan said he cut the repo rate because at "current policy settings, inflation is likely to be below 6 per cent by January, 2016," which is the target Mr. Rajan set after he took over as governor in 2013.
The same could have been said at the time of the central bank's latest policy meeting in early December, when Mr. Rajan was under pressure from Mr. Jaitley and several of India's business titans to reduce borrowing costs to boost industrial production. But Mr. Rajan opted to wait. And there would have been no harm in waiting another 19 days to make the announcement at the appointed time. India is facing no obvious economic crisis. The economy is strong by current international standards. The World Bank said this week that India is on track to overtake China as the fastest growing major economy within the next couple of years. The collapse in oil prices has caused inflation to decelerate quickly, but there is no present threat of deflation. There was no emergency.
Yet Mr. Rajan had a good reason to act when he did. He raised interest rates last year, even as economic growth slowed, vowing to end India's long struggle with inflation. The initiative drew comparisons to the slayer of inflation in the United States, former Fed chairman Paul Volcker. Mr. Rajan didn't care for the comparison, insisting that he was his own man. On Thursday, he reinforced that point, breaking new ground in post-crisis monetary policy.
After the global economy melted down in 2008, central bankers did considerable soul searching. They thought they had tamed the business cycle by targeting inflation and telegraphing their plans for interest rates. In the aftermath of the crisis, they worried that inflation targeting was the problem. More recently, a consensus has formed around the idea that central banks erred by making the path of interest rates too predictable – a one-way bet that caused investors to spend more time analyzing the inclinations of policy makers than the actual state of the economy.
Mark Carney, when he still was leading the Bank of Canada, talked about this in remarks at the annual Jackson Hole policy conference in 2009. The current Bank of Canada governor, Stephen Poloz, last year moved away from forward guidance, saying he would be clear about his interpretation of economic data, but that analysts would have to decide for themselves if conditions warranted a change in interest rates. Federal Reserve Chair Janet Yellen said at her final press conference of 2014 that when the Fed begins raising interest rates, it will not do so in a steady and gradual way, but instead introduce some uncertainty, a subtle rebuke of the way former Fed chairman Alan Greenspan did things.
Mr. Rajan now has moved ahead of his counterparts by acting on this emerging theory. In December, he said he could cut rates between meetings if data warranted such a move. Those who listened likely were rewarded by Thursday's rally. Those who didn't missed out on a chance to make some serious money. In the process, Mr. Rajan may have trained a legion to traders to read data rather than tea leaves. If he has, he may repeat as central bank governor of the year in 2015.
Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation.