Will Rajan Stay or Go Becomes Focus of India Rates Meeting

Updated on
  • All 35 economists see RBI leaving rates unchanged Tuesday
  • ‘His departure won’t be taken positively,’ Schroder says

Indian investors think they know what central bank Governor Raghuram Rajan will do with interest rates on Tuesday. Nothing. The big question is how much longer he will be around.

At Rajan’s traditional press conference minutes after the policy decision, dozens of journalists will grill him on live television over whether he will serve a second term after September and ruling party criticisms of his record. Foreign holdings of rupee bonds have fallen by 66 billion rupees ($986 million) since mid-May, when an ally of Prime Minister Narendra Modi sought Rajan’s dismissal for keeping interest rates unnecessarily high. The rupee dropped 1.4 percent last month.

“International investors attach a lot of credibility with Rajan and any question of his departure won’t be taken positively," said Rajeev De Mello, who oversees about $10 billion as head of Asian fixed income at Schroder Investment Management Ltd. in Singapore. “The debate about Rajan staying or not is going to be very important."

Speculation over Rajan’s future coincides with an expected increase in U.S. rates and an outflow of dollars as emergency currency swaps mature. The former International Monetary Fund chief economist has dragged the rupee from a record low, cut its swings by more than half and rebuilt foreign-exchange reserves since taking office in 2013. His inflation-targeting regime halved consumer-price increases.

All 35 economists in a Bloomberg survey see Rajan keeping the benchmark repurchase rate at 6.5 percent on Tuesday, after data last week showed the economy expanded a world-beating 7.6 percent in the year ended March 31. Swap traders aren’t pricing in any more cuts through 2016, according to data compiled by HSBC Holdings Inc.

The GDP growth trajectory should keep investors bullish no matter who helms the Reserve Bank of India, according to Pacific Investment Management Co. and Standard Chartered Plc. However, foreign holdings of local government and corporate debt fell by 99 billion rupees in 2016 amid an emerging-market sell-off after surging 2.2 trillion rupees in the last two years.

India’s rupee rose to its strongest in almost three weeks Monday on optimism investors will be lured to bond yields that are among the highest in Asia after disappointing U.S. jobs data fueled speculation the Fed will delay raising rates.

For Pimco’s views on Indian bonds and Rajan’s tenure, click here.

“We think the rates in India are fairly priced," said Hakan Aksoy, a London-based bond fund manager at Pioneer Investment Management Ltd., which oversaw the equivalent of about $250 billion at the end of March. "Having said that, Governor Rajan’s leadership at RBI is important from the central bank’s independence perspective, the markets prefer not to see a political figure in early September."

Financial markets won’t respond well if Governor Rajan doesn’t get a second term, Mohamed El-Erian, chief economic adviser at Allianz SE, told The Economic Times newspaper in an interview. Rajan is rightly deemed as one of the very best central bank governors in the world, he said.

FX Swaps

When Rajan took charge of the RBI in September 2013, the rupee was near a record low and the inflation rate was one of Asia’s highest. To stabilize the currency, he spurred inflows of about $34 billion through discounted foreign-currency swaps and worked with the government to establish an inflation target.

The majority of these swaps mature between September and November, and while the central bank is buying dollars to cover outflows, investors must expect volatility in the exchange rate, said economists at Kotak Mahindra Bank Ltd. Consumer price gains, which had eased from as high as 11.5 percent in November 2013, accelerated to 5.4 percent in April, above the RBI’s 5 percent target for March 2017.

That makes a rate-cut on Tuesday "very difficult," said Chetan Ahya, Morgan Stanley’s chief Asia economist. If the weather department’s forecasts are correct and rainfall is normal this year after two droughts, then the central bank may reduce the key rate to 6 percent by March 2017, he said.

“Rajan has done an incredible job and, in a period when the Fed is expected to raise rates and markets are going to be volatile, it will really make sense for Prime Minister Modi to be practical,” said Desmond Soon, Singapore-based head of investment management in Asia outside of Japan at Western Asset Management Co., which manages about $450 billion. “If they put someone else at the RBI, investors will perceive it negatively.”