When Rajan met Modi

The RBI is independent & Governor Rajan, a respected University of Chicago professor, is no pawn

Does Reserve Bank of India (RBI) Governor Raghuram Rajan have a reformist ally in Narendra Modi? Only time will tell if India's new Prime Minister Modi can scale up his fabled 'Gujarat Model' to revitalise Asia's number three economy. But there already are signs Rajan, India's central bank governor, is extending an economic olive branch to the new leader, which should cheer global markets.

The RBI is independent and Rajan, a respected University of Chicago professor, is no pawn. Nor can he afford to be a monetary pushover, given how India's eight per cent-plus inflation rate exacerbates the nation's crushing poverty. But Rajan seems willing to believe Modi's pledges to bring down inflation, and is willing to reciprocate the generosity. He did so this week by holding the benchmark repurchase rate at eight per cent and hinting he's willing to ease policy if inflation pressures wane.

After all, much of India's inflation problem comes from the supply side: Chronic inefficiency, terrible infrastructure and rampant corruption. Rajan has plenty of firepower to help Modi boost economic growth if, and only if, the government does its part. This unofficial pact between Rajan and Modi is a delicate one, and it could be scrapped at any moment. But if anyone in India has the gravitas to prod Modi to make good on his ambitious election pledges - to trim debt, rein in the current-account deficit and cut poverty - it's Rajan, who served as the International Monetary Fund's chief economist from 2003 to 2006.

I'm looking at this through the lens of my Washington days, when then Federal Reserve Chairman Alan Greenspan joined forces with President Bill Clinton to balance the budget. While both the Fed and the White House were coy about the arrangement in public, the Fed agreed it would go easy on interest-rate rises so long as Clinton and Treasury Secretary Robert Rubin did their part to reduce public debt. The bargain paid huge dividends as the US economy roared higher.

Can Rajan help unleash a similarly virtuous cycle in India? It's important to note this is the star economist's second big collision with Indian politics. The first, in October 2012, brought more frustration than success. Then Prime Minister Manmohan Singh shocked many in New Delhi when he hired Rajan as a top adviser to the finance ministry. Rajan was maybe the most acerbic critic of Singh's failure to deregulate the economy, liberalise the banking sector and reduce inflation. Soon enough, Rajan realised just how impossible a task that was when he saw the extent to which Singh was caught in the web of Gandhi family intrigue and corruption. Rajan, too, came in for censure.

Now he has a second chance. Rajan has had considerable success at the RBI since September 2013, helping to stabilise the rupee and stopping India from becoming the first BRIC nation -Brazil, Russia, India and China - downgraded to junk. Now that Rajan has a potential reform ally in Modi, we could see some fascinating cooperation between Mumbai, where the RBI is based, and New Delhi. With luck, India's 1.2 billion people will be the beneficiaries.

The writer is a Bloomberg View columnist