Central Banks

India’s Rajan sounds alarm on asset bubbles

Victor Mallet
Dhiraj Singh | Bloomberg | Getty Images

The world is at risk of another financial crash following a steep rise in asset prices, according to Raghuram Rajan, governor of the Reserve Bank of India – and one of the few people to have warned of the last financial crisis.

"Some of our macroeconomists are not recognising the overall build-up of risks," Mr Rajan, a former chief economist at the International Monetary Fund, said in an interview in the Central Banking Journal. "We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost."

Mr Rajan – whose words carry weight because he issued a warning about risk-taking in the financial sector three years before the 2008 financial crisis and the collapse of Lehman Brothers – expressed "alarm" about the build-up of financial sector imbalances.

India: Inflation pressure 'still very much there'
India: Inflation pressure 'still very much there'

"The problems arising are not so much from credit growth, which is relatively tepid in the industrial markets and has been much stronger in emerging markets, but from asset prices due to financial risk-taking and so on . . . 

"Financial sector crises are not as predictable [as those of economic growth]. The risks build up until, wham, it hits you."

Mr Rajan, who has previously criticised the central banks of developed economies for extending and then withdrawing liquidity without consulting potential victims in the emerging markets, said investors were talking as if they were gambling.

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"Investors say, 'we will stay with the trade because central banks are willing to provide easy money and I can see that easy money continuing into the foreseeable future'. It's the same old story. They add, 'I will get out before everyone else gets out'.

"They put the trades on even though they know what will happen as everyone attempts to exit positions at the same time. There will be major market volatility if that occurs. True, it may not happen if we can find a way to unwind everything steadily. But it is a big hope and a prayer."

Mr Rajan has said his current challenge as India's central bank chief is to tackle the country's high inflation to ensure sustainable growth – he kept the country's key interest rate unchanged at 8 per cent this week – but he is acutely aware of India's vulnerability to inflows and outflows of fast-moving foreign capital seeking better yields at a time of historically low interest rates in developed economies.

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"Of course, there is the age-old mantra 'let the exchange rate do the talking and then you are insulated'," he said. "That advice is garbage. A number of emerging markets are not insulated – you are affected, regardless of what kinds of policies you follow."

The eurozone was similarly affected at present by "a whole lot of money pouring in", Mr Rajan said. "It may bring down yields and push up asset prices, but it also pushes up the exchange rate. That creates a self-fulfilling process as more money comes because returns have gone up and the exchange rate has gone up."