Red; Orange; Green: RBI Governor Raghuram Rajan signals time for a global monetary review

India's banking chief Raghuram Rajan is recognised worldwide among a handful of those who had foreseen risks in the system before the 2008 financial crisis. As governor of Reserve Bank of India (RBI), he has become a leading voice for the developing world in international fora. During a recent visit to the UK, he articulated his traffic signal model to move the world towards a more responsible monetary policy. Raghuram Rajan has been very vocal for the need to move the world towards a more internationally responsible global monetary policy which follows the rules of the game. India's 23rd RBI governor, who co-authored 'Saving Capitalism from the Capitalists' back in 2003, believes India would very much become a key player in such a future policy. He said: “Today what you find in international fora is a lot of angst about the monetary policies that other countries are following but never any direct confrontation, because those policies are always ok because of the domestic mandate. “By the time any of this actually gets into policy, I have no doubt India will be among the top three-five global economies - around 10 years from now - and our monetary policy will also be subject to the same rules. It is time we started discussing.” Dr Rajan, who is on leave from the University of Chicago Booth School as professor of finance, called on the world of academia to conduct deeper research and analysis on how a reworked system that functions like a traffic signal could work in a decade's time. “We need some element of international responsibility in setting of monetary policy... We need rules of the game based on how policies play out in the short term versus long term, will they have negative effects on the rest of the world or positive effects Here I would use a driving analogy. “Policies that have a net positive impact on a country as well as zero to positive spillover effects for the rest of the world, let's give it a green label. Policies that are a little more uncertain, short-term negative but long-term positive, more of an orange label. “And policies that may be positive for your country but certainly negative for the rest of the world, now and for ever more, let's give it a red label and say countries should shun those kind of policies.” He called for a period of reflection, analysis and research so that the world can have policies that are more globally optimal rather than just domestically optimal and also warned that the adverse spillover effects of pursuing any aggressive monetary policy must be managed in time. “We need a lot more work, we need studies of what policies have been beneficial and what policies have been harmful. Once we have a reasonable number of studies, we then move to international discussion... and move to a context where we talk of rules of the game and international responsibility,” he said. As the architect of India's financial policies, the former chief economist and director of research for the International Monetary Fund (IMF) said it was a joy to formulate policy in a developing country like India. He notes: “There are many more places where good policy can have significant effects. In that sense, there are lots of low hanging fruit and often no real impediment to plucking them. “You have to be a little intelligent about what fruit are easy to pick and what are not so easy to pick. And if they are not so easy, what kind of strategies to pick.” In reference to India's infrastructure challenges and need for investments, the banking chief fears that greater demand on banks to hold capital in the post financial crisis scenario had come at a cost. “It made sense post financial crisis to ask banks to hold more capital. But one of the concerns bankers have been expressing, even if bankers may have low credibility because they have cried wolf too often, that eventually it will... create greater aversion to taking on risky lending. “We see some of that today. Certainly, as an emerging market central bank regulator, I see that foreign banks have stopped opening branches because our credit rating is BAA, which implies higher risk. From that perspective, international banks who are asked to put in money in India feel it is not worth it because they have to set aside a lot more capital.” Rajan likened the situation in India to that of small and medium enterprises (SMEs) in industrial countries, as in both scenarios the central factor is that more growth is required. “So we need to ask ourselves, is more capital good or is it likely to impinge on activities banks do. There is a trade-off and this calls for more empirical work as to what the right level of capital is.” In his conclusion at a recent lecture at Cambridge University, he highlighted why banks may be peculiar but were still enduring structures, which offered an efficient form of borrowing. “There is a reason why banks operate. All these proposals to do away with banks, to my mind, will cause serious costs on the system, it will increase the cost of financing and therefore we have to be very careful. “However, we do understand the consequences of systemic crises, they are severe, they are painful so more capital was warranted than what there was during the global financial crisis but we have to be careful about going too far.”