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Opinion

India's central bank is on the front line for Modi 2.0

Triumphant leader risks damaging economy if he interferes too much in financial markets

Shaktikanta Das has already cut interest rates twice for the boss.    © Reuters

Indian Prime Minister Narendra Modi did not single out Shaktikanta Das for thanks following his resounding re-election win.

But he should have done given the role the Reserve Bank of India governor has played in Modi's triumph -- and is likely to play in his second five-year term in government.

In Washington, Donald Trump rails against his central bank leader for not doing the White House's bidding. Modi seems to have that and more in Das, the third RBI head on his watch. Less than six months on the job and Das has already cut interest rates twice for the boss. It would be disingenuous to downplay the role that monetary support played in Modi's big win.

It also should be of grave concern for investors wondering what might come of New Delhi's economic reforms these next five years.

Calling Modi "boss" might seem hyperbolic if not for the experience of the two central bankers who preceded Das. The most immediate, Urjit Patel, was shown the door in December after just 27 months. Patel was too slow to ease for Modi's liking. He unnerved Modi's ruling Bharatiya Janata Party with ambitious plans to clean up the state-banking sector.

Before Patel, Team Modi collided with Raghuram Rajan. The former International Monetary Fund economist returned to Mumbai from Washington in September 2013 to stave off a mounting economic turmoil at the height of the Federal Reserve "taper tantrum.".

Rajan tamed runaway inflation, which topped 11% in late 2013. He stabilized the banking system and steadied the rupee, reassuring credit raters threatening to slap a "junk" label on India. Rajan, though, was too independent for Modi's liking. He was gone by September 2016.

Next in line was Patel who hiked rates twice in 2018, putting the benchmark repo rate up to 6.5% to curbing inflation and defend a sliding rupee. As U.S. President Donald Trump escalates his trade war, economies carrying budget- and current-account deficits, like India, may be in for particular punishment.

Das quickly went the other way with interest rates even though India remains the fastest-growing major economy. Tossing additional stimulus at an economy growing at above 6% annually offered Modi a nice re-election tailwind. But the costs of easy money might soon become apparent, and painfully so.

Increased Indian inflation could soon return to the headlines. As of April, consumer prices were just under 3%. Why risk India's hard-fought gains against surging living costs?

India needs to grow better, not faster. If India seeks to return growth to the 7% range, it should come from the supply side: reduced bureaucracy; increased competition across sectors; and efforts to improve education and training.

Cheaper money will not make India more productive. It might, however, restoke inflation.

Yet the bigger worry is that monetary support from Das reduces the urgency to implement structural reforms Modi did not manage in his first term.

Having set a precedent in RBI compliance, Modi 2.0 may demand ever greater monetary fealty. If Das fails to deliver, he may become the third central banker Modi dispatches.

India is not alone. In Manila, Benjamin Diokno is trying to balance inflation risks and a mercurial president. Earlier this month, Rodrigo Duterte's party won a solid mandate in congressional elections. Yet Duterte's success as a bold reformer is even less impressive than Modi's.

On the job less than three months, Diokno already pulled off the rate cut his predecessor would not -- by 25 basis points to 4.5%. With growth the slowest since 2015 -- 5.6% in the first quarter -- investors worry Duterte will lean on Diokno to hit the accelerator.

Like Modi, Duterte has cribbed from the Trumpian playbook of neutering institutions. First the press. Next the judiciary and legislature. After that, the central bank.

Investors wonder how Perry Warjiyo will fare in Jakarta. Indonesia's central bank marked one year in office last week just as President Joko Widodo's re-election win was being certified.

Investors wonder how Perry Warjiyo will fare in Jakarta.   © Reuters

Warjiyo has hiked rates five times to 6% to support a rupiah that had fallen to two-decade lows. Now, as the Philippines, Malaysia, New Zealand and India ease, can Governor Warjiyo stand his ground? With the current-account deficit rising to a four-year high near 3% in 2018, sobriety is warranted. So far, Widodo has trodden carefully on Bank Indonesia independence. But amid rising economic national among opposition parties, and growth slowing to 5%, political pressure to stimulate may mount on Warjiyo.

The Bank of Japan could have its own run-in with politicians. The Cabinet Office flagged "weakening" conditions since the first quarter, when Japan grew 2.1% on an annualized basis. Prime Minister Shinzo Abe's party faces upper house elections in July. There is even a chance of a double election that includes the lower house if Abe calculates it might help him cement control.

Markets risk being unnerved by monetary authorities from Tokyo to Mumbai bowing to lobbying. Rajan warns as much in his new book, "The Third Pillar: How Markets and the State Leave Community Behind." It tackles the populist backlash upending governments everywhere -- including India. Rajan serves up an interesting analogy: the RBI as "seat belt," and the government as the "driver" on the road to developed nationhood.

"If you do not put on your seat belt and get into an accident, the accident can be quite severe," argues one of the few economists who predicted the 2008 subprime crisis.

Rajan is particularly worried about the surge in borrowing since the "Lehman shock." In March, Standard & Poor's said debt among governments, companies and households jumped by 50% between 2009 and 2018 -- to $178 trillion. "There will be a crisis coming -- the question is when," Rajan says.

In India's case, both the driver and seat belt may be forgetting their function. In his first term, Modi slow-walked moves to implement land and labor laws or open key sectors like retail. Efforts to morph India to a manufacturing power lost momentum.

Das, meantime, has taken a far more appeasing approach than Rajan or Patel toward businesses, many of which are struggling to repay loans. In February, the RBI turned heads by effectively writing the government a $4 billion check.

The transfer, aimed at plugging a budget shortfall, left former RBI leaders like Yaga Venugopal Reddy (2003-2008) aghast. The problem, Reddy says, is that when a government moves to tap a central bank's capital, it "gives signals to the market."

If the signal is that Team Modi is increasingly calling the shots at RBI headquarters, then the next five years could see India veer perilously off course.

William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He was given the 2018 prize for excellence in opinion writing by the Society of Publishers in Asia for his Nikkei Asian Review work.

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