Raghuram Rajan: Sentiment is vital in short-term

Raghuram Rajan: Sentiment is vital in short-term

The 15th Chief Economic Advisor to the ministry of finance, Raghuram Rajan, explains to CNBC-TV18’s Siddarth Zarabi the challenges involved in turning India's fiscal scenario around.

The medium term potential for growth which entails moving people from agriculture to industry to services could result in a productive increase in growth for the next 15-20 years

Raghuram Rajan

Chief Economic Advisor 

GoI

Raghuram Rajan has taken over as the 15th Chief Economic Advisor to the ministry of finance in a long line of distinguished predecessors including present Prime Minister Manmohan Singh.

Rajan explains to CNBC-TV18's Siddarth Zarabi the challenges involved in turning India's fiscal scenario around. Rajan is also the Eric J Gleacher Distinguished Service Professor of Finance at the Booth School of Business at the University of Chicago and visiting professor for the World Bank, Federal Reserve Board, and Swedish Parliamentary Commission.

Below is an edited transcript of the interview on CNBC-TV18. 

Q: From your perch as chief economic advisor, is the nation’s fiscal situation bad enough to warrant a ratings revision?

A: The obvious answer is no. Let me try and explain the reasons. The economic trajectory didn't look good- growth was falling off and inflation relatively high compared to other economies in the world and our current account deficit is large.

So, it became important to try and change the situation around and that’s why the steps were taken in the last few days. But going forward, there are decisions that have to be taken to hopefully change the trajectory around.

Most important in the short-run, is to allow investors' sentiments to start reacting to the tremendous upside in India. The medium term potential for growth which entails moving people from agriculture to industry to services could result in a productive increase in growth for the next 15-20 years. But what needs to be established for the domestic and the foreign investors is the road and the means via which this growth potential can be achieved without accident.

One of the big concerns over the last few months has been the fall in domestic investment by corporations. The decline has been substantial since the 2007-2008 period. The key challenge lies in restoring the sense of confidence in our own investors to generate the growth that we all need.

But I think the initiatives in addressing this challenge have already started. These initiatives have changed sentiment and reality, and in the longer run I think they would put this country on a much better fiscal footing. I think the credit-rating agencies will recognise this.

The agencies are, of course, looking at the current situation, but I think they should be heartened by the capacity for reforms that have been announced in the last few weeks.

Q: Do you think it is very important for the government to heed to the rating agencies and send out a clear, unequivocal message that India is willing to respond to criticism?

A: If you see the reforms announced during the last few weeks, I don’t think they are responses to criticism, but a reflection of the administration’s understanding of what needs to be done.

Regarding credit rating agencies, I am neither dismissive of them as they are full of sensible people who take reasonable decisions, nor do I emphasise their ability to see into the future.

However, they do play an important role in determining who can invest in Indian debt because if you are below investment-grade a certain quality of institutions cannot invest. At a time when the global economy is fragile and a cloud of fear haunts the investor at every turn, it would be silly to declare that a downgrade doesn't matter.

Though we can endlessly debate how much a credit-rating matters, let us avoid it if we can. This does not imply that we announce and implement reforms with rating agencies in mind.

All decisions must to be taken with the long-term health of the economy in mind and improvement in the fiscal health is as important for the aam admi as it is for the rating agencies. In the end, in a financial crisis, it is the people at the bottom who suffer the worst.

Q: Do you feel that the economy has reached a dismal situation after several years of good growth? Has India slipped back into the Hindu rate of growth?

A: No. I hope we haven't got anywhere near the Hindu rate of growth of 3.5 percent and hopefully we will stay way away from it. But clearly the drop in corporate investment has to be addressed as a serious concern and turned around in time. Though more confidence and predictability need to be established, it is a process rather than an overnight reform. I think there are decisions we can take to increase the pace of realization of projects that are already underway or near completion. There are projects that have stalled because of permission and problems with linkages.

However, the finance minister has assured that the problems will be sorted out and the Prime Minister has suggested that action will be taken along these lines to increase the pace of project-completion. But I think reviving the pace at which new projects are created has to be our focus because that is what is going to create growth in two-to-three years down the line. That implies changing the investment sentiment today and making the public and the private corporate sector see the value of investment.

Q: Given the magnitude of the problems that have piled up, does India need to be prepared for sub-par growth in the next two-to-three years?

A: I define sub-par as 8.5-9 percent. That is where we should be.

Q: Are we going to be there anytime soon?

A: Reaching that pace of growth should be our goal and its not going to happen overnight. We should overcome domestic constraints and at least create the conditions to reach the upper-end of the projections estimated by various economists and planning bodies.

I think there is no reason or excuse in the long run for India not to grow at 8-9 percent. But how long it will take depends partly on what we do and partly what the outside world does. India's period of very strong growth during 2003-2008 was when the world economy was also doing very well. Close to 45 percent of India's economy is dependant on the world economy via imports and exports. So, we also need a strong world economy to get back to those levels of growth, but let’s at least make the condition of the economy more conducive.

Q: How much of the problems and the lack of confidence during the last two years do you think are driven by domestic factors?

A: I think we tend to be overly self-critical at times and unduly uncritical at other times. I do think that a part of the blame for the slowdown in growth has to be laid on the global situation. Trade this summer looks awful across the world and our slowdown is partly due to that.

But not entirely. Domestic issues have also played a part such as the fall in the corporate investment. But let’s take a balanced view. We need to do our homework and then we cross our fingers and hope that the world economic also recovers strongly.