Will Raghuram Rajan find a way?

RBI has its back to the wall. Liquidity tightening is stifling India Inc. But what can the new RBI Governor do?

Challenging times are ahead for Raghuram Rajan. Despite all the measures the RBI has taken, the rupee is slipping and sliding. The Indian economy is slowing, a bit alarmingly. The US Fed has announced a tapering of the QE that would tend to reduce precious dollar flows that the Indian economy needs. Bond yields have shot up. Business is borrowing at a higher cost. Payment cycles are expanding. Indian companies are facing a slowing environment.

But will the new bank governor find a way?

The rupee, which looked extremely weak since morning, cheered Raghuram Rajan's appointment as governor of the Reserve Bank of India. It rebounded from its all-time low of Rs 61.80 to close at 60.77 to the dollar.

One of the things the Indian economy clearly needs is a stable rupee.

To give the RBI its due, dollars have been fleeing the country after the US Fed announced a tapering to its QE. The RBI has struggled to curb speculation in the rupee and has tightened liquidity. Clearly, that's not helping much. The rupee is still in a tight spot.

The liquidity-tightening measures will cut through India, Inc's balance sheet as borrowing is stifled. Most companies have a working-capital cycle of anywhere between 45 and 90 days. Banks play a crucial role in funding that cycle. Companies grow and expand their businesses – and demand for working capital further increases.

In fact, corporate watchers contend that if things continue for three months or so, India Inc. could come to a grinding halt.

But what are the options in front of Raghuram Rajan?

There's only so much the RBI can do. One is to raise interest rates. This could cause pain to the banks and to the economy, but it would help stabilise the rupee. The other is to allow the rupee to depreciate slowly, which would again cause pain. Foreigners though would find the rupee turning attractive at some point. Raghuram Rajan could undo the liquidity-tightening measures thus alleviating the pressures of hard credit for corporate India, but that would let speculators loose.

Raghuram Rajan has talked about improving productivity, bettering the skills of the workforce.  He wrote in May 2012 that the crisis is a wake-up call and “In the United States, that means educating or retraining the workers who are falling behind, encouraging entrepreneurship and innovation, and harnessing the power of the financial sector to do good while preventing it from going off track.”

But these are long-term challenges and have wider scope than the mandate of the RBI – that of fiscal policy management. For the immediate moment, we need to somehow stabilise the rupee.

At a press conference after being appointed as RBI Governor, Rajan said that there's no magic wand.

But there's no doubt that the Indian economy needs some dollar inflows urgently if the rupee has to stabilise. If somehow Raghuram Rajan can find that magic wand to attract dollars in a large way in the immediate term, we would not need to go through the crunch of rising inflation, higher interest rates and a grindingly painful slowdown.