Finder of Financial Fault Lines

• Author: Laura Wallace
• Position: a communications consultant and former editor-in-chief of F&D.

Raghuram Rajan, now the head of India’s central bank, was the IMF’s youngest, and first nonwestern, chief economist.

But when Rajan, then 40, turned up at the IMF’s Washington headquarters in 2003, many of his peers thought he had entered the wrong building. The finance professor from the University of Chicago was reporting to work as the new economic counsellor and director of the Research Department. But although he was a highly regarded finance economist, he was filling a job that had always been held by a leading macroeconomist. And to the macroeconomists who populate the IMF, Rajan was an unknown entity.

But the IMF picked Rajan for a reason: it wanted to build up its financial expertise in the wake of the Asian financial crisis of the late 1990s. Anne Krueger, then the IMF’s second in command as first deputy managing director, had recently read a book Rajan coauthored with Luigi Zingales, Saving Capitalism from the Capitalists (2003), so she called Rajan. When asked if he would be interested in being chief economist, Rajan says he told her: “Well, Anne, I don’t know any macroeconomics.” To which Krueger joked, “Neither do I.” He decided to give it a shot and flew out for an interview.

A decade later, when Rajan reported for his first day as governor of the Reserve Bank of India (RBI), no one doubted that he had entered the right building. It was as if all his academic work since his 1991 doctoral thesis on the dangers of cozy bank-firm relationships had been leading up to this day. Plus his stint at the IMF had given him valuable experience, not only in policymaking but in engaging with advanced economies. As one former colleague puts it, Rajan can stand his ground because “he isn’t in awe” of the major industrial powers. In addition, he was one of the few economists to have warned about the risks of financial innovation well before a devastating financial crisis hit the United States in 2007 and then disrupted the global economy.

The demands on, and expectations for, Rajan are high—domestically and globally. He is leading India’s central bank as the country tries to regain its economic momentum, and policymakers around the world look to him for guidance on reforming the global financial system. Unsurprisingly, the Chicago professor advocates free markets, but, as he wrote in the 2003 book, he also views the market as “a fragile institution, charting a narrow path between the Scylla of overweening government interference and the Charybdis of too little government support.”

That said, it is difficult to put Rajan into a particular economic camp. He likes to call himself “a pragmatist.” As he tells F&D: “It’s not just economics but the political layer that is imposed over it that determines outcomes—and the political layer is much less well understood than the economics. So when you combine the two, basically it’s a process of navigation. How do I make sure that sensible economics prevails?”

Saving capitalism

Rajan was born in Bhopal, in central India, in 1963, but spent much of his early youth in Indonesia, Sri Lanka, and Belgium (his father was with the foreign office) before returning to India at age 11. He says his fascination with finance dates to his graduate school days at the Indian Institute of Management in Ahmedabad, which followed a bachelor’s in engineering from the Indian Institute of Technology in Delhi. He recalls reading Nobel laureate Robert Merton’s theory of rational options pricing (a formula for evaluating options, which are contracts that give a buyer the right to buy or sell a financial asset at a set price in the future). He was struck, he said, not only by the theory’s “mathematical elegance” but also by “its usefulness in the real world.” In 1991, he received a doctorate in finance at the Massachusetts Institute of Technology’s Sloan School of Management and became an assistant professor at the University of Chicago’s Booth School of Business—both institutions that attracted the top options-pricing researchers.

For most of the next 12 years, Rajan would make Booth his home, teaching...