The government’s decision to ban high denomination currency notes was not well planned, said former Reserve Bank of India (RBI) governor Raghuram Rajan, adding that he had told the government that it was not a well thought-out, useful exercise when the idea was first mooted.

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With essentially all money that was demonetised coming back into the system, the exercise didn't have the direct effect that was sought, said Rajan at the Harvard Kennedy School in Cambridge in the US where he delivered a lecture on Wednesday.

India demonetised 1000 and 500 rupee notes without printing the required currency, he said. “Any economist would say when you are demobilising 87.5% of the currency, better print it.”

Rajan had earlier commented about his reservations about demonetisation, but Wednesday’s comments were his most forceful yet on the subject.

Any economist would say when you are demobilising 87.5% of the currency, better print itRajan said demonetisation had a negative economic impact and added that thinking currency hoarders would come out post demonetisation was a naive view.

The government had launched demonetisation in 2016 in an attempt to crack down on black money in the economy.

On the government’s other important reform – goods and services tax (GST) – whose rollout was hobbled by glitches, he said it’s not an unfixable problem. “It'll be nice if we could implement much better than we do. But we can work on it. I wouldn’t give up hope at this point on that, he said.

Rajan shed light on how he approached the job as India’s 23rd RBI governor.

India then was one of the Fragile Five economies and the Indian rupee lost about 25 percent of its value, according to him.

It wasn’t easy. “In industrial countries one doesn’t bother about the exchange rate –it’s just another price -- but in emerging markets, when the exchange rate is moving 1.5-2 percent every day and it's a reflection of what the markets think about you, it's something that worries you a lot,” he said.

The biggest questions before the RBI then was “how do we stabilise this damn thing before it sort of collapses”. But heeding to the advice of his economist friend Agustin Carstens, Rajan said he began to stop talking about the exchange rate and started talking about inflation. “We talked about all the reforms we would do to get inflation under control including an inflation targeting and all the structural reforms we would do to get growth up.”

“Once the exchange rate is under control everything else sort of becomes easier because you don't have investors panicking every day and try to figure out what's going to happen,” said Rajan who is now the Katherine Dusak Miller Distinguished Service Professor of Finance at Chicago Booth.

But the fight against inflation had to be gradual because India doesn't have the buffers like say, an unemployment insurance, according to Rajan, who was also previously the chief economist and director of research at the International Monetary Fund. “You can't put 10 percent of the economy out of work and still survive as a central bank Governor. You have to take the extent of pain that that people can absorb. So it had to be a gradual disinflation.”

Other key takeaways from the talk:

On China: The comparison that is often made between India and China is often unfair to India. He said India pales in comparison to China because today China is about five times its size and per capita is about the same because populations are approaching each other. But he said the India story would be a much less impressive one only when compared with China. “India is a very impressive story. (Look at the) 7% GDP growth over the last 25 years.”

What India has not done that China has done is build infrastructure, according to Rajan. “An enormous part of Chinese manufacturing growth has got a much better logistic access to ports, access to roads and so on, which India does not have. Why is there a difference? The difference is because of both property rights and democracy. Property rights in the sense that in China they were much less defined; you could take the stuff, everything belonged to the state. In India, you can't do it because if you take it, it gives an entrepreneurial politician the incentive to organise those people and to fight.” Building infrastructure in India is very hard because you are running over so many people's land, he said. “You have a close to first world civil society, you have very entrepreneurial politicians, but you have a third world administration. So put that combination together and it becomes very hard to acquire land and build those mega projects.”

On India: Rajan said India’s advantage is that it is a democracy. “Ultimately I believe the strongest system for growth is not a state-run system or an autocratic system. When you are at the frontier, a liberal market democracy to my mind is the strongest system because of the various checks and balances built into it.” In the next phase of growth, once the catch-up growth happens, which could be another 10 years, India is much better positioned to stay there for longer, he said. “There is a lot we have to do, but it just seems to me that we should not forget that we have some strengths also.”

On working in India: Rajan said it is easy to get disillusioned when you go down to India because the systems are old. “I mean in India for example, my first day in the finance ministry, I got files this thick (gestures) on my table. We are still working with paper files where you have to note I agree, I don't agree, here are the reasons I agree, and here are the reasons I don't agree.” He said one has to really have to figure out where a difference can be made in such a system. “Now often you find, so long as you are not antagonising somebody too much and so long as they can take some credit for what you do, they are pretty happy to work with you. So you need to figure out how to play the political game a little, don't sort of bang against it like a like a bull in a China shop, but find your way through the system.”

You need to figure out how to play the political game a little, don't sort of bang against it like a like a bull in a China shop, but find your way through the system

On interest rates in India: Rajan said the big borrowers in India loved a system of negative real interest rates for obvious reasons, and the depositors were getting shafted time and again. “However, they had this illusion that they were getting 9 percent and they did not realise inflation was 10 percent. So by switching from the wholesale price index (WPI) to the consumer price index (CPI) which was much lower and making that our inflation target, we switched the regime overnight and said we would now move to a regime where interest rates would be at least positive in real terms.

The borrowers did not realise that was the import of the switch, according to Rajan. “Eventually they realised that this meant higher real interest rates for them and then they started banging on the table and said inflation targeting is a terrible thing and let us go back to the old ways. However, it was too late.” The good news as a result is Indian household savings are starting to pick up because of these positive real interest rates, he said.

On education: India, Rajan said, sometimes suffer from the problems of fads in other countries being transmitted. “For example this idea of continuous evaluation … let us do away with exams … let us evaluate these kids on a continuous basis that will make for much stronger evaluation makes a lot of sense in Lexington. But in an Indian school where you have 60 kids and this teacher has to do continuous evaluation, what kind of continuous evaluation are you going to get?”

The result is students are promoted without checking whether they understand, he said. “So the quality of (education) is falling tremendously and part of this has been exacerbated by the Right to Education Act, which sort of brought in all this fancy stuff that works very well in Delhi, but not in in Bihar, which where we need the big change.”

First Published:Apr 12, 2018 12:03 PM IST