Reviewing Raghuram Rajan’s Real Monetary Policy


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Raghuram Rajan’s monetary policies have received both praise and flak. On one hand, they have been praised as stabilizing forces in a tumultuous global economy awash with central bankers’ reduced interest rates. On the other hand, critics have denounced Raghuram Rajan’s policy changes as being detrimental to growth. This article assesses the impacts of Raghuram Rajan’s policies on the economy and the ‘real’ effects of the global banking crisis. You’ll read insights on how these inflation targeting policies have safeguarded the Indian economy. Read this Raghuram Rajan monetary policy review to find out if Raghuram Rajan’s successor should continue them, or implement new policies.

When the RBI Governor Raghuram Rajan announced that he would not be keen on a second term, economists, markets and the investing world as a whole were very disappointed. Many felt that his successor would have a difficult task filling his shoes.

On the other hand, some of his critics within and outside Government were not unhappy. The general criticism levelled against his policies was an excessive focus on inflation management and not enough on spurring growth. His critics believe that the RBI – like central banks elsewhere – can foster growth largely by reducing interest rates. Indeed many blamed the current low credit growth in the country on these policies.

As we at Multi-Act look back on the Governor’s journey, we believe that the most important thing he focused on was maintaining positive, “real” rates as a pre-requisite to non-inflationary growth and sound capital formation. We believe this was the right thing to do in the current situation, even though it flew in the face of so many global central bankers, who have reduced interest rates across countries and regions to near-zero or even negative levels. They have done this in the misguided belief that low interest rates will create a “wealth effect”, boost consumption, and hence economic activity.

Instead, Rajan clearly stated that the Central Bank would only focus on inflation rates while deciding on interest rate policies. He believed that interest rates need to be in line with inflation, so that depositors have a “real” return for saving, and borrowers pay a “real” rate to ensure that they do not engage in mal-investments. Indeed, we believe that the massive NPA issue that Rajan has had to grapple with is nothing but the consequence of past episodes of severe negative “real” rates, especially during 2008-2011, that spurred the economy temporarily but at a huge long term cost.

The “Real” Legacy

A “real” interest rate is an interest rate that is adjusted to remove the effects of inflation. It helps a borrower gauge the “real” cost of funds and enables the borrower to ensure that the investment yields a “real” return sufficient at the very least to pay for the cost of the borrowing.

First, in a low interest rate or negative interest rate regime the tendency of companies to take on more debt increases. However, if banks pass on these low rates to depositors (consumers), the consumers in turn have less money to spend. Low demand would further affect companies’ revenues. Even in a low demand, low revenue environment companies will have to service the debt that they had taken on. Eventually debt repayments overtake the ability to invest, further giving rise to a deflationary cycle. Second, if banks choose to keep deposit rates high while lending rates low to spur credit growth; this will lead to eventual losses in the banking sector, and is obviously not sustainable.

We believe that the Governor was right in focusing on “real” interest rates because that allows for real growth where one part of the banking system is not boosted at the expense of hurting the other. He was defiant of ‘experts’- primarily global central banks and Keynesians – who preach a low and lower interest rate regime as a cure-all.

Problems in the continual administration of such a low interest rate regime are surfacing in the US economy. BusinessWeek (June 13, 2016), reported that the level of debt of non-financial companies that are rated by S&P has crossed $6 trillion – which is more one-third of the US GDP! Outside the top 1% of such companies who are cash-rich (Apple, Google, Microsoft, etc), the ratio of cash in hand to debt is at its lowest point in 10 years, says S&P. And the economy is not growing fast enough to help generate more profit in the near future. This is sure to create a major problem in the corporate bond market when the lack of credit worthiness, in the absence of access to the capital markets to roll over the debt, becomes evident. The Emerging Market debt situation is no different.

Cleaning Up the Banking System

Rajan’s second focus was to clean up the balance sheets of the banking system by forcing banks to recognize non-performing assets (NPAs), and bringing accountability of borrowers across the private and public sector. Again, his critics believed that this was excessive and would work to cripple the banking sector. However, at Multi-Act we have been quite vocal about the fact that banks’ balance sheets have been an ‘illusion’ in the past – they have been made to look better than they are (read the blog post here). Many observers believe that the huge amount of capital required to recapitalize banks will not be available to banks when push comes to shove.

Our view, however, is that once the balance sheets of banks are fully cleaned up over the next few years, and there is confidence that the culture of lending and accountability of loans has permanently changed for the better, there will be sufficient amounts of private capital (domestic and foreign) that will be attracted to take advantage of the fast-growing Indian economy and its financial sector. Hence, the banking system, in our opinion, will attract requisite funds when recapitalizing.


Amidst global uncertainties, Governor Rajan has been able to provide much needed stability to the Indian economy. His policies of insisting on a “real” rate to compensate savers, transparency in the case of public sector bank balance sheets and accountability of borrowers to their lenders is a beacon, especially when other central banks are pursuing expedient policy alternatives at the expense of a sound financial structure. We hope his successor will continue with his policies.

About Multi-Act

Multi-Act was founded in 1997 by two Wharton graduates, to develop an Equity Research capability for their own investments. Today, we employ 50 people who operate out of our offices in Mumbai and Pune and service a range of clients from wealthy families, family business owners to sophisticated investors and capital intermediaries around the globe.

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