Letting Raghuram Rajan go—or worse, pushing him out—is certainly a major foolishness on the part of the government. Of course, it isn’t the only mistake the government has made, nor is this the only government that has delivered a litany of errors. I guess the sum total of a government’s errors/mistakes/foolishnesses—and their impact—will determine whether it is brought back to power or not.
The real issue then is what will be the medium-term impact of the move, and, as I think about it, perhaps this was a very carefully thought out political move. If Rajan had been given a two year extension, his time would be up in September 2018, just as the next Lok Sabha election was heating up. Assuming Rajan continued to perform as well as he has (and his media status was correspondingly stronger), replacing him at that time would have risked creating unnecessary uncertainty; better to push the button now. Further, it is unlikely that the certain knee-jerk negativity surrounding Rajan’s departure will persist till then.
Politics trumps economics again, as it does in most governments—certainly including this one.
So, what will be the fall-out of Rajan’s “return to academia”?
In the immediate term, of course, there will be rupee weakness and increased uncertainty. RBI has already been in the market guns blazing to prevent the opening slide—it had crossed 68 in the NDF market this morning—from turning into a rout, and the reserves are quite sufficient for this. There is an immediate risk that the Brexit vote (on Thursday) could compound the problem, but the good news is that the most recent polls suggest the “Remain” camp is likely to win. This would—again, in the immediate term—turn Brexit into a non-event for markets, since the positioning is being adjusted virtually minute-by-minute.
A little further out, however, there could be many forces which weigh on the rupee, which is still, of course, driven by the balance between global risk sentiment and India’s “special” place therein. First off, even if Brexit doesn’t happen, there could be an increased swell of pressure in Europe as anti-European parties (right and left) in several countries. Again, there is a Fed meeting in July (and another in September) which could, as it does sometimes, raise the prospects of a rate hike. And, there is the ongoing reality show of the US presidential election; here, too, events and polls will keep the market off balance. All of these could—and, from time to time, will—send waves of shivers into the market, notably the de-Rajaned rupee.
And then, of course, there is the September repayment of the FCNR borrowings. While there is supposedly a sound plan to manage this without too much volatility, there will be, by this time, a new Governor in the RBI. Markets—certainly, the off-shore ones—will, without doubt, test the new Governor by pushing the rupee lower. Increased volatility in September seems certain— traders could buy volatility for that month.
The more important issue, though, is the medium term. A lot will depend on the new Governor and whether he (or she) sustains Rajan’s policies of singular inflation management, aggressively cleaning up the banking system (which includes pushing against crony borrowings), and keeping the currency steady to provide comfort to global investors. I don’t think Rajan’s personal attractiveness to global investors will play a big part—there are several skilled well-qualified people to fill the role (the institution is bigger than any single person, as the refrain goes) and, ultimately, money has no morals. If the new Governor shows good sense and doesn’t slip on any of the initiatives that Rajan started, India can well retain its favored investment destination status. However, if the global macro environment falls apart, we will be affected like everybody else.
Of course, Rajan will be a tough act to follow and the new Governor will need to, in very short order, define his/her position to the market. This will likely require winning a skirmish or two with the government. Indeed, if the government doesn’t want to compound the Rajan mistake, it should actually set up some relatively unimportant skirmishes which it permits the new Governor to win. This may seem a little devious but, hey, that’s the nature of the beast.
The one change that is very likely is increased volatility in the rupee. As always the best approach to managing this risk is to (try and) stay away from forecasting the currency and follow a structured process that eschews punting, ensures definitive benchmark protection and enable some opportunity gains. We have an increasing number of clients who are shifting to this kind of approach.
The author is CEO, Mecklai Financial