With Rajan Undone by Indian Politics, Pressure Rises on Modi

  • Finance minister says successor will be announced shortly
  • Rajan decision said to have caught Modi government by surprise

Raghuram Rajan will exit India’s central bank after unnerving political leaders with calls for free speech and religious expression. The focus now shifts to whether Prime Minister Narendra Modi can find a successor able to command credibility both with investors and his Hindu-based party.

The man who captured international attention with a prescient 2005 speech warning about a buildup of global financial risks on Saturday declared he’ll leave the Reserve Bank of India at the end of his term in September. The outgoing governor made clear that he was ready to continue: “I was open to seeing these developments through,” he said of his work on reining in inflation and addressing bad loans in the banking system.

Raghuram Rajan
Raghuram Rajan
Photographer: Prashanth Vishwanathan/Bloomberg

As someone who spent several decades overseas, Rajan became a key target of Hindu hardliners in Modi’s party who don’t always cheer educated Indians who build their careers abroad. The former International Monetary Fund chief economist wasn’t shy in speaking out on topics outside monetary policy. He used his post as a bully pulpit to advocate for going after tycoons he described as crooked, liberating the poor from “venal" politicians and calling for tolerance in a nation vulnerable to religious violence.

To read more about Rajan’s calls for tolerance, click here.

Dealing with Rajan, 53, presented a challenge for Modi, who built a pro-business, pro-deregulation record as chief minister of Gujarat state yet also relied on Hindu nationalists to secure the historic win that swept him to office in the 2014 national election. In recent weeks, the prime minister and his finance chief, Arun Jaitley, did little to rein in pointed attacks by Subramanian Swamy, an outspoken lawmaker with a large Twitter following who said Rajan was “mentally not fully Indian" and kept interest rates unnecessarily high.

As recently as June 7, Rajan told reporters to watch for statements from Modi and Jaitley regarding his future, joking that it would “be cruel for me to spoil the fun the press is having with all this speculation." Modi’s administration repeatedly said a decision on the RBI governor would be made in August, weeks before the end of Rajan’s term.

Yet in the past few weeks, Rajan was disappointed that Modi’s government was dragging its feet on giving him a second term and failing to back him publicly against attacks, according to a former top official familiar with the deliberations over Rajan’s extension. In discussions with the government, Rajan wasn’t given assurances over a second term, the former official said.

Rajan Surprise

Rajan’s letter on Saturday caught Modi’s government by surprise, according to another person familiar with the situation. The administration saw the consultations between Rajan and Jaitley over his second term as still ongoing, and it has no obvious successor lined up, the person said.

Now with Rajan heading out the door, pressure may rise on Modi’s government for an accelerated timetable. When a local newspaper reported that Rajan had told Modi he didn’t want another term, it prompted the rupee to retreat -- showing the potential impact Rajan’s weekend news might have on the financial markets when trading opens Monday.

Jaitley moved swiftly to address risks over the lack of a succession plan, saying in a Facebook post after Rajan’s letter that “a decision on his successor would be announced shortly." In the three-sentence statement, Jaitley said the government “respects his decision."

‘One of the Few’

Finance Ministry spokesman D.S. Malik declined to comment on the deliberations, while Jagdish Thakkar, a spokesman in the Prime Minister’s Office, didn’t answer two calls to his mobile phone.

Rajan’s announcement left economists and private-sector players scratching their heads. The broad consensus had been that the government would eventually give Rajan a second term despite the political noise, due largely to the wide respect that Rajan commands among industrialists, investors and economic leaders around the globe.

Lawrence Summers, a former U.S. Treasury secretary who criticized Rajan as “Luddite" for his 2005 warning of a financial crisis at the elite Jackson Hole annual economic gathering, on Saturday said he was “one of the few central bank governors who has changed the regime in a major country."

‘Messy Politics’

“I wonder what precipitated him to take this action,” Deepak Parekh, chairman of Housing Development Finance Corp., India’s largest mortgage lender, told Bloomberg Quint, Bloomberg’s India television and digital venture. D.S. Rawat, secretary-general of the Associated Chambers of Commerce and Industry of India, expressed hope that Rajan would reconsider the decision.

"Once again messy politics gets the better of good economics," Mohamed El-Erian, chief economic adviser at Allianz SE, said on Twitter.

Rajan’s announcement marked a clear political win for the Hindu-nationalist elements in Modi’s Bharatiya Janata Party. Swamy cheered the decision, saying on Twitter that his admiration for Modi “has gone up hugely" because “he did not bend" to pressure to extend Rajan’s term.

Modi triggered Rajan’s exit with a campaign of “insinuations, baseless allegations and puerile attacks" on the governor, according to Palaniappan Chidambaram, a former finance minister in the previous Congress party-led government.

“India is the loser," said Chidambaram, who appointed Rajan as governor in 2013.

Rajan Legacy

The governor leaves the legacy of an official inflation target and the forthcoming establishment of a Monetary Policy Committee -- a framework that could offer his successor institutional structures to maintain independence from the government. He also stabilized the rupee amid volatility over the shift of the U.S. Federal Reserve from stimulus to liquidity-withdrawal mode, and forced lenders to set provisions for bad loans in a bid to clean up the banking system -- an unpopular move among politically connected Indian elites used to easy money.

Yet it was Rajan’s outspoken call for tolerance last year amid a debate over religious discrimination that really got him in trouble with segments of Modi’s party. Jaitley defended the government’s record the next day, while Swamy called for Rajan to be fired.

Tensions started to build again last month, when Swamy wrote a letter to Modi questioning Rajan’s allegiance to India. The Modi administration offered limited reaction, while calling on the media to avoid speculating about Rajan’s future.

Successor Search

Now the search for his successor is on, and credibility is a key concern among investors. Among the names that have been speculated are two Finance Ministry officials -- Arvind Subramanian and Shaktikanta Das -- central bank Deputy Governor Urjit Patel and the head of India’s biggest state-run bank, Arundhati Bhattacharya, who would be the first woman to head the RBI.

One view in government is that India doesn’t need a high-profile central bank governor, the Times of India reported on Sunday, citing an unidentified source.

“Sadly India is unlikely to see another academician as an RBI governor," said Kunal Kundu, a Bengaluru-based economist at Societe Generale SA. “It would most likely be a bureaucrat."

In many ways, Rajan used his time at the central bank to make the institution less dependent on one person, particularly with the new rate-setting committee and the inflation target. Yet they are still in their infancy, untested by any period of high oil prices or the potential new round of capital outflows in the event of a Brexit.

‘Badly Bungled’

And then there’s Swamy. Besides attacking Rajan, he’s also called for India to scrap inflation targeting altogether. Although Modi as recently as March lauded moves to rein in prices, there are political events on the horizon that may create the incentive for urging cheaper borrowing costs. Elections in India’s biggest state next year, and national polls in 2019, may also tempt the government to open the spigot on spending, escalating inflation pressures.

“No individual in government is indispensable -- Rajan was no exception," said Milan Vaishnav, a senior associate in the South Asia Program at the Washington-based Carnegie Endowment for International Peace. “But the government badly bungled the situation, and it deepens concern about the level of talent in the present government. Surely, this experience will give pause to other bright minds who would like to serve the country."

Before it's here, it's on the Bloomberg Terminal. LEARN MORE