World economy may slip to 1930s-like depression: Raghuram Rajan

August 7, 2015

The global economy is “slowly slipping” into Great Depression-like problems of the 1930s, Reserve Bank of India (RBI) Governor Raghuram Rajan has cautioned, asking central banks from across the world to define the “rules of the game” to find a solution.

Rajan, among the few to have predicted the 2008 financial crisis, said the problem was a “broader” one and for the entire world, not just for industrial countries or emerging markets. The former International Monetary Fund (IMF) chief economist, who had earlier warned against competitive monetary policy easing by central banks globally, said the situation was different in India on this front, adding RBI was more focused on reducing lending rates to spur investment.

“We need rules of the game in order to effect a better solution. I think it is time to start debating what the global rules of the game should be on what is allowed in terms of central bank action,” he said at a London Business School event here. The RBI governor was addressing a conference organised by AQR Asset Management Institute on ‘The Central Banker Perspective’.

“I am not going to venture a guess as to how we establish new rules of the game. It has to be international discussion, international consensus built over time, after much research and action,” he said.

“But I do worry that we are slowly slipping into the kind of problems that we had in the 30s in attempts to activate growth. And, I think it’s a problem for the world. It’s not just a problem for industrial countries or emerging markets. Now, it’s a broader game.”

The Great Depression refers to a period of severe global economic downturn in the 1930s, which had affected almost all countries. It began in 1929 and continued till the late 1930s, the longest and most widespread period of global economic depression.

Asked about interest rate cuts from an Indian perspective, Rajan said, “I try to shut out market reactions as far as I can. We (India) are still in a situation in which we have to spur investment and I am worried more about that….So, I shut out the asset price reaction and think more about ‘is this going to bring bank lending rates down and, therefore, channel cheaper credit into firms and then they will invest?’ However, the issue gets much more complicated for other markets.”

Rajan highlighted the tremendous pressure for growth, which in turn created enormous pressure on central banks to take action. Seven years after the economic crisis of 2008, central banks had a lot, both during and after the crisis, he said.

In 2005, during his tenure at the IMF, Rajan had written a research paper, ‘Has Financial Development Made the World Riskier’, in which he had said developments in the financial sector had made the world “much better off”. But this development, he said, had also led to the emergence of a whole range of intermediaries and “under some conditions, economies may be more exposed to financial sector-induced turmoil than in the past”.

At the London Business School event, Rajan said: “The question is are we now moving into a territory in trying to produce growth out of nowhere or we are, in fact, shifting growth from each other, rather than creating growth?…Of course, there is past history of this during the Great Depression, when we got into competitive devaluation.”

During the first four years of the Great Depression, global gross domestic product is estimated to have fallen about 15 per cent. The crisis is said to have been begun in the US, with the ‘Black Tuesday’ stock market crash of October 29, 1929. During the Depression, global trade is estimated to have more than halved and countries recorded decline in tax revenues, corporate profits and personal income. Unemployment had soared, with widespread impact on industry and agriculture.

Rajan also highlighted the need for countries to work together on capital flows. “We have to become more aware of the spillover effects of our actions and the rules of the game that we have; what is allowed and what is not allowed needs to be revisited.”

PSBs will need additional capital: RBI

Reserve Bank of India (RBI) Deputy Governor R Gandhi (pictured) on Friday said state-owned banks were “adequately” capitalised at present but would need additional money to comply with global capital adequacy norms in the future.

“Right now, the banks are adequately capitalised. That is right. What we are telling banks and the government is going forward, keeping in view the future growth that is likely to come in economy and also based on Basel-III norms, additional capital will be needed…prevention is better than cure, so if banks are adequately capitalised well in advance, that gives a lot of confidence to banks,” Gandhi said.

Press Trust of India | London June 26, 2015