Why Wall Street's Worried About the End of Rajan's Reign

Will the reformer's work go unfinished?

Raghuram Rajan Plans to Return to Academia

The Indian rupee slumped as investors reacted to the news that Reserve Bank of India Governor Raghuram Rajan will return to academia in early September.

At India's central bank, the former International Monetary Fund chief economist not only oversaw a revolution in the conduct of monetary policy but also pushed for structural reforms and commented on fiscal policy, often drawing the ire of lawmakers in the process.

Rajan, along with Bank of England's Mark Carney, is one of the two 'rock star' central bankers of this generation. At the Jackson Hole symposium in 2005, he famously warned of excessive and growing imbalances in the financial system that manifested in the crisis of 2008.

A government official highlighted five possible successors for Rajan, but for now, analysts are scrambling to get a handle on what the governor's departure means and how markets are likely to be affected.

Here's what strategists are saying about Rexit:

Deepali Bhargava, economist at Credit Suisse AG:

"We think that the governor's unexpected departure is a negative for the currency for two reasons: first, the fact that political pressures may have contributed to his departure would raise uncertainty over the new monetary policy framework put in by Dr. Rajan, including inflation targeting. Second, Dr. Rajan has been credit[ed] for helping stabilize the Indian rupee after the taper tantrum volatility, and hence possesses [a] certain degree of credibility in FX management."

Bhanu Baweja, strategist at UBS AG:

"Amid intense market focus on short-term risks such as emerging market outflows and a Fed tightening cycle, we believe incumbent Reserve Bank of India (RBI) Governor Raghuram Rajan always took a longer term view. We've been in agreement with Rajan's view that low inflation, far from being negative for growth, is precisely what is needed to finance long-term growth by incentivizing savers to move from gold and into financial instruments. That he is not continuing is a concern in some respects; it may reflect pressure to maintain cyclical growth at the cost of giving up structural improvements."

Ben You Ang and David Marshall, analysts at Creditsights Inc.:

"Indian Banks will be viewing the impending departure with a mixture of regret and relief. The relief will be felt by bankers and borrowers who felt threatened by the RBI's push to bring to light all the bad loans on the books of the banks, forcing bankers to clean up their books and adopt more stringent lending standards. The regret will be felt by those who applauded its efforts to end a lending culture heavily influenced by politics and relationships rather than the soundness of the borrowers and the viability of their projects. The departure of Mr. Rajan as head of the RBI will inevitably be seen as a blow to the reform of the Indian banking sector and this is probably true."

Pranjul Bhandari, chief India economist at HSBC Bank Plc:

"Over the last three years, Rajan has introduced many changes at RBI and alongside the macro fundamentals of the country have improved significantly. Some of these tasks remain unfinished. The MPC is yet to be formed and the bank balance sheet clean-up is still underway. Encouragingly much is on auto-pilot; but because leadership matters for early days of institution building, there is risk that some efficacy of these reforms gets diluted."

Ashish Kumar, economist at Elara Securities Ltd.:

"As Governor Rajan leaves, there are still validity tests required on his various initiatives. Absent the international developments that continue to pose short and long-term risk, he needed to see a full cycle of his policy initiatives take shape. Inflation targeting, an idea that is losing favor in global policy discourse needed to prove its relevance for India. Three years is a small time to conclude that macro-economic stability can be achieved with a nominal anchor in inflation … A careful analysis suggests that central banking is now much more rule-based in India and much of the discretionary power will be gone for the new incumbent. On three major functions of the central bank including a) Monetary Policy, b) Banking Regulation, and c) FX management, the discretion of RBI governor is now at a historic minimal level"

Mallika Sachdeva, strategist at Deutsche Bank AG in a note published prior to Rajan's announcement:

"Rajan's future was the subject of most discussions. A minority believed that 'where there's smoke, there's fire' and the risk of his departure was real, while others felt better economic sense would prevail. Even without the Rajan risk though, many noted that the fixed-income story was getting shakier, with the recent turn higher in inflation, further risks from oil and the Pay Commission implementation, and a still large off-index position on bonds by offshore real-money."

Siddhartha Sanyal, chief India economist at Barclays Bank Plc:

"It is beyond doubt that Governor Rajan has been a strong face for India during the country’s journey in the last three years from one of the 'fragile five' economies to arguably the most preferred emerging market investment destination today. A large number of investors and business leaders in the recent past indicated their preference for Dr Rajan continuing for longer. However, there had been a lot of media speculation in recent months about Governor Rajan’s term coming to an end in September 2016. Nevertheless, the timing and manner in which the announcement was made came as a surprise; the Finance Minister had indicated recently that the decision around the re-appointment of the RBI governor might take place as late as in August."

Rachel Ziemba, senior research analyst at Roubini Global Economics LLC:

"RBI Governor Rajan was seen as a key macro anchor, coming to office after India deployed defensive measures amid the taper tantrum. Although he’s struggled to fulfill some elements (public banks), he’s brought credibility when the Modi government compromised on reforms (GST [Goods and Services Tax Bill] bankruptcy law, public bank clean-up) … Key signposts include the identity of the new RBI governor and the government's commitment to inflation targeting and reforms such as the GST. One of Rajan's achievements was the development of the monetary policy council, which limits the power of the RBI governorship. In the current political context, this may actually reduce the RBI’s independence - suggesting that the convergence toward price stability we mentioned in our recent analysis may be premature."

Samiran Chakraborty and Anurag Jha, economists at Citigroup Inc.:

"While some knee-jerk reaction to this event is quite possible, we expect the markets to wait for more clarity on the new Governor’s name and more importantly his views on continuity versus change. If the new governor is able to strike a right balance between the two then he will gain credibility and market focus is likely to shift back to improved macro fundamentals."

Timothy Ash, head of EMEA Credit Strategy at Nomura International Plc:

"Man, now alongside Brexit next week, EM has Rajanit to worry about....India, was one of the few good news stories in Asia, alongside Indo[nesia], with most of the rest looking troubling."

Sanjeev Prasad, co-head of institutional equities at Kotak Institutional Equities:

"We are quite baffled by the development as continuity would have been preferable in the context of (1) the RBI’s organizational progression (formation of MPC among other things), (2) the Indian banking system’s large non-performing loan problem; the RBI was playing a central role in addressing the problem and (3) an uncertain and volatile global environment, especially with the Brexit referendum due on June 23."

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