The Reghuram Rajan effect has produced two days of continuous upswing on both stock market and Rupee. Amidst a crisis produced negative sentiments, the market was searching to find something to cheer and they rightly found an energetic Rajan. It seems that more than the entry of Prof Rajan, markets were celebrating the exit of Subbarao.
Financial markets have big trust in the new Governor than in P Chidambaram. The support measures suggested by Prof Rajan are more realistic than those made by Sri Chidambaram. It is to be remembered that the stocks and rupee tumbled when the Finance Minister declared his support measures couple of weeks back.
So far the story is going fine. But an immediate question we should find an answer is that how far the new Governor can continue the magic disregarding some negative fundamentals in the economy. Prof Rajan has produced a badly needed psychological momentum. But can he sustain it?
At the same time, the seven point medicines prescribed by Prof Rajan seems to be difficult to implement; though they are theoretically right ones. An important one is the proposal for trade settlement in domestic currencies. For such agreements, it will take time and efforts from the Government and different Ministries including Commerce and Finance. Simultaneously, India’s major partners also should join such efforts.
Presently, China has domestic currency settlement agreements with its major partners. India has not joined the Chinese efforts at the BRICS.
Markets should remember one thing; no central banker is a market man. There were hot debate in history and theory about the role of central banks in supporting stock markets. The famous Bernanke- Gilchrist Hypothesis advocates that central banks should not play to stabilise stock markets.
Central bankers are not known to play for the galleries. So is Prof. Rajan. Market will see the true central banker in Raghuram Rajan when he comes out with next monetary policy declaration on 20th of this month. His ability to straighten a falling currency and a weakening economy is credible but probably only in the short run. The doctor is good, but the disease is worse to cure.
The present crisis is mainly due to structural default in the economy like poor manufacturing sector – leading to falling exports and increasing imports, lack of government investment in productivity raising ventures. Such structural faults can’t be corrected with cyclical measures by a central bank which has only limited ammunitions. Markets will correct its expectations on Prof Rajan in the coming weeks.