Mr. Rajan correctly predicted a global financial bubble in 2005. Reuters
WASHINGTON—India’s new central bank governor, Raghuram Rajan, is waging a vigorous two-front war.
At home, Mr. Rajan is trying to repair the damage inflicted on his country’s decelerating economy after investors this summer retreated from emerging markets in anticipation of an end to easy-money policies in the U.S.
Abroad, he is campaigning to persuade the U.S. Federal Reserve and other central banks that they need to pay more attention to the consequences of their actions for the developing world and do more to mitigate the fallout.
This past week, he brought his fight here to Washington, where the International Monetary Fund was holding its annual meeting.
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“If you want stronger global demand, you really need to think about international arrangements to deal with these issues,” Mr. Rajan said in an interview on the sidelines of the meetings. He urged a process by which the central banks of advanced nations give greater weight to the global spillover effects of their policies.
In May, mere mention by the Fed of an eventual shift sparked a global emerging-market selloff. In the three months that followed, India’s currency lost nearly a quarter of its value. Stocks dived.
Countries from Indonesia to South Africa, Brazil and Turkey also got slammed, as investors, betting that returns in the U.S. would rise, pulled their money out.
“The volatility” that capital flows cause “on the way in as well as on the way out…is a cost. And we should weigh these things,” Mr. Rajan said.
As lawmakers in Washington strive to overcome differences to avoid a U.S. debt default—another event that could have global repercussions—Mr. Rajan said publicly this weekend that India wasn’t selling its U.S. assets.
Unlike many other international critics of advanced nations’ policies, the 50-year-old Mr. Rajan has solid establishment credentials. The Massachusetts Institute of Technology-trained economist served as chief economist of the Washington-based IMF and taught at the University of Chicago.
And he has been right before about the unintended consequences of Fed policy.
Famously, in 2005 he warned a roomful of Fed officials in Jackson Hole, Wyo., that the world risked a dangerous financial bubble.
In January, Mr. Rajan, at the time an adviser to India’s finance minister, warned his counterparts at a meeting in New Delhi of officials from the Group of 20 industrial and developing nations that they should wake up to the dangers posed to emerging markets by an end to easy-money policies in the U.S.
The response, two senior Indian officials present at the meeting said, was a collective shrug. Representatives of advanced economies said, in effect, why worry about something that wasn’t going to happen soon.
Since this summer’s drastic emerging-markets pullback, more developing countries have become vocal about their concerns.
Mr. Rajan said if the developed world—which for years flooded the globe with liquidity in an effort to revive growth in its own flagging economies—doesn’t pay adequate attention to the impact of its policies on developing countries, it could end up sowing the seeds of another crisis.
“Are we in a world where we continue to blow up bubbles elsewhere?” Mr. Rajan said.
He has raised this topic in several forums around the world this year, including at the June annual meeting of the Bank for International Settlements, an international organization of central banks. The event was attended by more than 200 central bank and government officials from around the world.
“Emerging economies’ perspective in general is that this has been a challenge, and [Mr. Rajan] has been certainly channeling those concerns,” said Jean Boivin, a senior official at Canada’s finance ministry, who co-chaired some of the G-20 working-group meetings this year.
The question is: Has anyone been listening?
“I think the U.S. has been, to some extent, sensitive to the criticism,” India’s finance minister, Palaniappan Chidambaram, said in an interview. “In September, when it was widely expected that the taper will begin, they put the taper on hold. And I think they have acknowledged that it was necessary on their part to communicate their intentions.”
Still, many central bankers from industrial countries say it is up to emerging markets to fend for themselves.
Developing economies “have considerable control over how this works out and what the stability conditions are inside their own countries,” Donald Kohn, a former Fed vice chairman who now is a member of the Bank of England’s Financial Policy Committee, said at a meeting of central bank officials in Jackson Hole in August.
The standard response from advanced countries has been that emerging markets should respond to the capital outflow by letting their currencies adjust. But this isn’t always practical advice, Mr. Rajan said, since it can lead to a sharper-than-warranted depreciation as, he said, happened in India in the summer.
“You’re using special tools because you’re saying the economy doesn’t work as advertised,” said Mr. Rajan. “Then you’re telling us” to follow a textbook response, he said.
Back home in India, Mr. Rajan and others are trying to take steps to soften the blow when the Fed really does start tightening in earnest. There are serious problems to tackle. In India, inflation has inched up, partly because of the depreciation of the rupee, which makes imported goods more expensive.
In a surprise move, Mr. Rajan raised the benchmark interest rate by a quarter percentage point to 7.5% in late September, in a bid to keep price rises in check. “You have to focus on bringing inflation under control” to provide greater stability to the rupee, Mr. Rajan said.
Mr. Rajan has lowered the rate on an emergency liquidity facility, which to some extent blunts the impact of the higher benchmark interest rate.
But there will be pressure on Mr. Rajan to think about more than just inflation at a time when India’s growth has slowed sharply. Some economists expect gross domestic product to grow less than 5% in the financial year that ends March 31, the slowest pace in more than a decade.
“He pissed off a lot of people” by raising rates, said a former official of the Reserve Bank of India. The official added that the central bank faces pressure both from the government and business to keep rates low.
Mr. Rajan said that despite the currency depreciation and economic weaknesses, India has more than enough reserves to pay its foreign debt and has taken steps to resolve long-term structural problems. “It’s not a crisis,” said Mr. Rajan.
However, for the world at large, he said, the potential for growth might not be as high as previously thought, since a lot of it was driven by cheap credit in recent years. “Take off the easy money and true growth may be lower,” Mr. Rajan said.
—Nirmala Menon contributed to this article.