India named a former International Monetary Fund chief economist to head the Reserve Bank of India on Tuesday, giving fresh impetus to efforts to revive a struggling economy and a currency that is languishing at record lows.
Raghuram Rajan, who predicted the global financial crisis in 2005, will take over at the RBI from Duvvuri Subbarao, whose turbulent five-year tenure ends on September 4.
Rajan is viewed as a pragmatist on monetary policy likely to stick fairly closely to Subbarao's line on managing inflation. The outgoing governor fought an uphill battle against price pressures for much of his term in an economy plagued by supply-side bottlenecks and legislative and bureaucratic paralysis.
Bhopal's Raghuram Rajan becomes new RBI Governor
"(Rajan) has the intellectual pedigree and policy experience, but my worry is people will think a smart guy coming in will fix all of India's problems," said Bhanu Baweja, head of emerging markets strategy at UBS in London. "The problem in India is political consensus and execution. By itself, the appointment doesn't change my view on the market. I am underweight the rupee and Indian equities," Baweja said.
India's record current account gap of 4.8 per cent of GDP makes it highly exposed to global flows away from emerging markets in anticipation of tighter US monetary policy. Reforms are especially challenging for a weak ruling coalition headed by Prime Minister Manmohan Singh that faces elections by next May.
The rupee is down nearly 11 per cent in 2013, making it the worst-performing currency in emerging Asia,. Emergency steps by the RBI in July to drain liquidity and raise short-term interest rates have failed to halt its decline.
It fell to a record low of 61.80 to the dollar on Tuesday before buying by the RBI helped the rupee post a gain. Meanwhile, economists have been cutting their growth forecasts for an economy that expanded by just 5 percent in the last fiscal year, its weakest in a decade.
"These are challenging times for the Indian economy, though no one can have any doubt about the country's promise," Rajan said in brief remarks late on Tuesday.
"The government and the Reserve Bank are working together to address these challenges. We do not have a magic wand to make the problems disappear instantaneously. But I have absolutely no doubt that we will deal with them," he said.
In a March interview with Reuters, Rajan said he believed inflation around 5 per cent in a developing economy is "reasonable," putting him on the same page as Subbarao, who set 5 per cent as medium-term goal and 3 per cent as a long-term target.
In recent months, Rajan has tended to speak in favor of pro-growth policies, as well as talking up the need to address the current account deficit. "In the last two months, he has been taking a key role on rupee-related steps, and his appointment as the governor will lift expectations of constructive and positive steps to lift the rupee," said Siddhartha Sanyal, an economist at Barclays in Mumbai.
An alumnus of IIM-Ahmedabad and IIT-Delhi, Rajan did his doctorate from the Massachusetts Institute of Technology. Rajan was also involved with the report on Financial Sector Reforms, which was authorised by the Planning Commission.
Informal and outspoken, Rajan brings global stature to a post that in recent years has been held by career bureaucrats. At 50, he is also young by Indian central bank chief standards.
The former University of Chicago professor gained fame with a 2005 paper at a US meeting of central bankers, warning that financial sector developments could trigger an economic crisis. The argument, later spelled out in his book "Fault Lines," was dismissed by many as alarmist.
Lawrence Summers, the former US Treasury Secretary seen as a frontrunner to succeed Federal Reserve Chairman Ben Bernanke, said at the time the paper's premise was "slightly Luddite," and "largely misguided."
Summers later apologized for the remark, said Douglas W Diamond, a University of Chicago Booth School of Business professor who has written several papers with Rajan on monetary policy and financial stability.
"Raghu's soft voice willing to speak against accepted doctrine" will likely help raise the profile of India's central bank, Diamond said.
"He's going to have a big impact on other central banks. He'll be widely listened to in the community of central banks," Diamond predicted, saying Rajan comes in as an "incredibly well-known academic," just as Bernanke was when he took over as Fed Chairman.
In a Reuters poll, 13 of 15 respondents said Rajan was the best-suited to the RBI job. Other candidates were said by government insiders to include Economic Affairs Secretary Arvind Mayaram and Planning Commission member Saumitra Chaudhuri. Subbarao ruled himself out of a term extension.
Rajan had been considered the most likely candidate to be the next governor when he returned to India last year to accept the top advisory post at the Finance Ministry in New Delhi, although some in government had said his relative outsider status might count against him.
Based in Mumbai, the RBI is not statutorily independent, although its governor has enjoyed wide policymaking latitude. Unlike Subbarao, Rajan favors the formation of a monetary policy committee, departing from the current autocratic power enjoyed by the governor, a set-up that would bring the RBI more in line with the practice at major central banks elsewhere.
During his tenure, Rajan will also oversee the issuance of new bank licenses to corporate houses under a policy pushed by the finance ministry but opposed by many in the central bank. Rajan was appointed to a three-year term. Subbarao was also initially appointed for three years, and his tenure was then extended by two years.
"He's got an incredibly strong sense of public service," said Anil Kashyap, a Booth School of Business professor who has co-authored several papers with Rajan.
Kashyap said Rajan is also "really, really down to earth," and did a lot of "grunt work" at the university, like serving on committees. "He always thought that was part of what economics is good for, being able to help people," he added.