June 23, 2016    4 minute read

The “Rexit”

   June 23, 2016    4 minute read

The “Rexit”

The decision made by Raghuram Rajan, an Indian economist to no longer serve a second term as the 23rd Governor of the Reserve Bank of India (RBI – the central bank of India) put the Indian economy in distress. There is no secret regarding interest rates disputes between Prime Minister Narendra Modi’s government and Rajan’s RBI; the government has never been keen on Rajan’s perseverance on chasing after gradual interest-rate cuts to encourage price stability nor was the government interested in his responsibility as a public intellectual within the society. Despite all this, there were powerful motives to believe that the government would have attempted to keep Rajan on board.

To begin with, losing Rajan contradicts the government’s commitment, prodigious in recent history, to drawing the attention of foreign investment to India. Modi spent more time than ever since he has taken office in the summer of 2014 to do business with foreign investors – this effort had spurred a surge in capital inflows. It is not long ago that India will for the first time in history allow for full foreign ownership of companies to support the claim that India is open for business negotiations.

The positive waves of these alterations have the potential to be alleviated by Rajan’s departure. At the end of the day, his outstanding inflation management which kept the Indian rupee stable backed Modi’s effort to draw Foreign Direct Investment (FDI). The build up of other macroeconomic indicators under Rajan includes the boost in foreign-exchange reserves and diminished current-account deficits and motivated confidence in potential investors.

So Why Did He Leave?

Regarding the driver behind the official exit of Rajan was the ruling party’s opposition to his determined attitude on inflation, it seems that investors’ confidence will tremble though it may be imperfectly covered by the publication on softened foreign-investment standards.

Moving on, another reason for Rajan’s exit being a surprise is the fact that Modi’s government had a reputation for making difficult, demanding decisions, instead of addressing to populist policies in its fiscal policy management. Yes, significant constraints had been felt by trying to hold the fiscal deficit at discrete levels. That did not stop the government from putting the blame regarding the lack of demand on Rajan saying no to the idea of rapid interest rates cut and go on to say the finance ministry failed to cut taxes or raise spending.

Were Lowering Interest Rates A Good Idea?

Nonetheless, before forming a judgement regarding the practicality of lowering the interest rates in India, let’s take a look at some of the facts. First of all, disinflation has been correlated with a transition period in an economy – the time the country experiences poor growth. For examples, countries that held its patience and control over the negative situation such as Chile were rewarded with sustainable growth; on the other hand, those that gave in such as Argentina resulted in stagnated growth and high inflation.

Secondly, there are plenty of potential culprits besides interest rates that are responsible for few job opportunities and investment in India. A significant volume of bad assets and imminent debts within large-scale companies in India had created a fallacious connection that keeps pushing the country further and further away from achieving feasible economic growth – this cannot be just solved by interest rates cut. Take a look at Japan; the negative interest rate is clearly not an answer in recovering the country’s economic growth.

The last two years of the harsh grind of Rajan-led RBI and the Modi-led government had the Indian economy a triumphant end of the journey in becoming a part of the emerging-market economies. However, seeing how the conflict between the Modi-led government and the Rajan-led RBI affected the economy, it is fair for investors to be worried as India may get caught in conflicting economic governance which may cause the economic growth to come to a halt. With rising instability, the European Union facing issues such as Brexit, the Chinese hard landing and the recovering commodity prices have put Indian economy in a tight position.

Instability

The incident of Rajan’s exit or “Rexit” has left India’s credibility cloudy and it is without a doubt that Rajan would have been an excellent candidate as the leader of the monetary policy through this difficult period.  Now that he has chosen “Rexit”, one can only hope for Modi and his government to make sure that the future candidate for the Reserve Bank of India has the strength and competency to maintain the institution’s reputation and guide the country into moving forward. In short, Rexit could in its ways turn out to be as deleterious to India as Brexit to Great Britain.

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