After Rajan, the deluge

Raghuram Rajan will leave behind many notable achievements when he steps out of Mint Street as governor of India’s central bank in September. He has calmed prices, tamed the rupee and built a robust foreign exchange reserve — no empty boast in his three-year stint as the country’s chief economic officer. Yet, there are already warning signs that the pressure on the rupee will build up once more around the time of his exit, or Rexit, as it has been termed by popular media. A humungous $20 billion is expected to flow out of the economy between September and November, as redemptions become due on the foreign currency non-resident deposits that he allowed the banks to mop up soon after his ascension to RBI’s top office.

Also, with food prices already rising and the full force of monsoon still playing truant, there is no gainsaying where real inflation is headed by the time Rajan packs up his bags for the campus in Chicago, from where he has been on leave of absence. Prices of pulses, sugar, grain and vegetables have already been rising. Mounting pressure on the currency, along with rising prices at home could, in fact, derail Rajan’s now famous inflation targetting, on which, has been shaped much of the Reserve Bank’s monetary policy under him.

Worse, exports are headed nowhere — they contracted for the 18th month running in May. Should inflation go haywire, not only would any downward adjustment in policy rates be put on the backburner, but the central bank might get irretrievably bogged down in tackling inflation. Who knows, in due course, despite the joint monetary management with the finance ministry, a new governor might be tempted to push policy rates upwards, making credit that much more expensive for the industry, even as private sector capex remains elusive.

Add to that the uncertainty over Brexit — Britain’s possible exit from the European Union, the US Federal Reserve’s pussyfooting on a long-overdue rate hike and rising crude oil prices, and Dalal Street has serious reasons to get nervous when the bell rings for the start of trading this morning.

And unlike what the soothsayers have to predict about a “temporary” disruption before the market eventually calms down, the tremors might as well last for longer than the Narendra Modi-led NDA government would have bargained for, no matter what the usual list of suspects being touted as Rajan’s likely successor.

The government knows this well. Which is why market regulator Securities and Exchange Board of India (Sebi) is bracing for adverse fallout on Dalal Street today. Sebi and the stock exchanges are said to have beefed up their surveillance and risk management mechanism to ring fence the market from excessive volatility. Banks and forex dealers have also been told to gear up to meet any excessive demand for dollars. Press Trust of India has quoted unnamed government officials that brokers, portfolio managers and other market intermediaries would be under a close watch for any attempt to lure small retail investors with promises of hefty gains from the futures and options trading, especially in banking stocks and indices.

This newspaper believes that the rupee will come under pressure during today’s early trade. Should the currency volatility acquire a defining trend over the next many days, the government will have serious concerns. An analysis by Financial Chronicle Research Bureau (FCRB) of the rupee-dollar rate in the three years before Rajan become RBI governor reveals a highly volatile exchange rate, in a 50 per cent band between Rs 44 and Rs 66 level (see chart). In the two years and nine months that he’s been in government, this volatility was significantly curtailed with the rate moving in a 17 per cent range between Rs 59 and Rs 69 to the dollar. This is what Rajan referred to while patting himself on the back for stabilising the currency, in his parting note to colleagues.

Meanwhile, it’s true that Rajan’s ability to manage the foreign exchange reserve was helped partly by lower crude oil prices in the last two years. Yet, the rise in reserve was dramatic beyond the benefit accrued to on account of lower oil price. For three years before Rajan assumed charge at RBI, the country’s forex reserve stagnated at $280 billion. The amount has since risen to $363 billion, rising almost 27 per cent (see chart).

On a slightly optimistic note, however, a weak rupee is likely to mute the response of the equity market to Rajan’s exit. As the IT stocks carry a higher weight in the Nifty index, they tend to perform better whenever the rupee comes under pressure. But that’s all there is to the positive spin, if any, because business is otherwise not growing for the IT giants themselves.

We also foresee some hammering of banking stocks, and expect long-term institutional investors to ignore them in the absence of any defining policy for the banks, once Rajan calls it a day. For, he alone can be credited for tackling the menace of bad debt and financial access. With Rajan out of RBI, there is fear that the fight against bad loans could weaken.

Of course, over the medium-to-longer term we also expect the government to give the short shrift to inflation management to prove a point about kickstarting economic growth and boosting market sentiment. It is likely to do so by easing policy rates, on which it had significant differences with Raja, and which is what its advocate Subramaniam Swamy has been pushing for in public discourse, in between bad mouthing the outgoing governor.

This is also reason why economists that this newspaper spoke with on Sunday believe that Rajan’s departure could lead to finance ministry’s dominance in monetary policy.

“I am worried about finance ministry dominating the central bank in coming future, particularly through the monetary policy committee and other things,” said NR Bhanumurthy, professor at New Delhi-based think tank National Institute of Public Finance and Policy. He also expressed concern over the shape of public debt management agencies if fiscal dominance of monetary policy happens.

“As I understand the kind of NPA (non-performing assets) we are seeing now is just a small portion of what is going to come in the future. So, it all depends on how the central bank and finance ministry are going to tackle this. It is bigger concern for me than WPI and CPI,” Bhanumrthy said.

However, former chairman of the national statistical commission Pronab Sen felt the RBI governor’s exit would not have any substantial impact on the macroeconomic situation and the market. “It is a pity that Mr Rajan is going back, but it is a decision that he had to take. It is a good thing that he has taken it earlier rather than later. At the end of the day, an individual is not more important than an institution,” Sen said.

By- Rajesh Gajra, Rajiv Nagpal & Nirbhay Kumar

(This story originally appeared on Financial Chronicle)