Rajan warns of abrupt reversal of global low interest rates

Reserve Bank of India (RBI) Governor Raghuram Rajan, who had predicted the 2008 financial meltdown, has said that abrupt reversal of low interest rates globally could create substantial amounts of damage and it should be done in a predictable and careful way.

He was also worried that altering the price of capital for substantial period of time distorts investment decisions and the nature of economies.

"We're in the hole we are in. To reverse it by changing abruptly would create substantial amounts of damage. So, I'm with (US Federal Reserve) officials in saying that as we get out of this, let's get out of this in a predictable and careful way, rather than in one go," he told the Time magazine.

He was asked whether quickly reversing low rates could backfire.

Asked whether super-easy money had led to misallocation of capital, he said his greater worry was that by altering the price of capital for a substantial period of time, "are we also, in a sense, distorting investment decisions and the nature of economy we will have".

"Have we artificially kept the real rate of interest somehow below what should be the appropriate natural rate of interest today and created bad investment that is not the most appropriate for the economy?"

To a question whether long term low interest rate mean trouble, Rajan said his sense was that monetary policy can do only so much and beyond a certain point it does more damage than good.

A number of years over central bankers have convinced markets that they will continuously come to their rescue and will keep rates really low for long that has pushed asset prices beyond fundamentals and made markets much more vulnerable to adverse news, he said.

Asked about the lack of coordination in the global financial system led by the US, he said the US should recognise that actions of emerging economies to protect themselves over the long run have come back to affect the US.

He said there was room for greater dialogue on how these policies should be conducted not just to be nice but because in the medium run it was in the US' own self interest.

"If you are not careful about the volatility you create, others will have to respond, and everybody is worse off," he said.