At first glance, India’s Prime Minister Narendra Modi and its central banker Raghuram Rajan make for unlikely bedfellows. Modi is a homegrown politician from a working-class background, a card-carrying member of the Hindu Right who mostly speaks in Hindi. Rajan is a U.S.-educated economist, a liberal whose family was a part of India’s civil service elite. He's spent most of his working life abroad and speaks only a smattering of Hindi.
Yet their fates are now linked. This week both men reached symbolically important milestones: Modi has passed 100 days in office, while Rajan has finished his first year as governor of the Reserve Bank of India. Together they bear the burden of huge expectations for a turnaround in India's moribund economy. Their reputations alone have prompted an early uptick in sentiment. To maintain momentum, though, they need to start acting more like the bold reformers everyone expects them to be.
Reputation can go a long way, of course. In a country where nepotism and connections usually determine who occupies high public office, Modi and Rajan represent a refreshing change. Neither of them are insiders in New Delhi, whose halls of power are as clubby and claustrophobic as Washington's Beltway. Both are high achievers with undeniably successful track records. Modi won three elections as chief minister of Gujarat, India's most industrialized state, because of his economic stewardship. Rajan is a prescient academic who became the International Monetary Fund's chief economist at the tender age of 40. To Indian businessmen, they exude a credibility and competence that is rare at the highest levels of India's government.
To this point, both men have benefited from improving economic conditions globally and locally. In the months before Rajan took office, emerging market currencies including India's were battered by hints that the U.S. Federal Reserve would begin to taper its massive quantitative-easing program. By the time Rajan arrived, that fear had largely receded.
The RBI governor can take credit for projecting a sense of confidence and placing his faith in a tight money policy, despite opposition from the incumbent, Congress-led government. The rupee, which had lost 20 percent of its value in six months before he took over, is now stable. Inflation, which had reached double digits, is three percentage points lower.
For his part, Modi benefited from a late rearguard action by the previous government, which in its last year in office tried belatedly to correct skewed macroeconomic indicators, including the fiscal deficit and the current account deficit. That helped drive gross domestic product growth from below 5 percent to 5.7 percent -- the highest rate in nine quarters -- between April and June. (Modi was inaugurated at the end of May.) Anecdotal evidence suggests that investors, both domestic and foreign, are now slowly loosening their purse strings. But hard data is still lacking.
If confidence has risen because of Rajan and Modi, though, so have expectations. Indians want to see a return to 8 percent growth and inflation below 5 percent. To achieve that, real structural reform is necessary. Modi has to bite the bullet on foreign investment; to date he has taken only half-measures such increasing foreign investment limits in insurance and defense from 26 percent to 49 percent. He also needs to tackle the subsidies and welfare programs which are bloating the fiscal deficit and crowding out efficient private investment. So far he has left them untouched.
For his part, Rajan needs to reform the financial system radically. He could start by being bolder about changes to the Reserve Bank, which plays too many and conflicting roles. It sets interest rates, manages government debt, regulates banks and controls the bond market. Ideally, it should only be filling the first of these roles.
Time is on Modi’s side: He has four years and nine months before the next election. Rajan has two years left in a three-year term, which may be extended to five. Sooner or later, though, positive sentiment will no longer be enough to carry either man. Now is the time to start meeting the outsized hopes they've raised.
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