There is speculation on the extension of the term for Dr. Rajan as it comes to an end in September this year. Currency markets could view a non extension of term for the governor extremely unfavourably and the INR could lose its stability in such fragile markets. The government would do well not to break the relationship Dr. Rajan has developed with the INR if it wants investments to come into the country.
RBI has adopted a CPI inflation target of 5% for FY 2017 and has cut rates from 8% levels to 6.50% levels under Dr. Rajan. RBI is seen as a central bank that is maintaining its independence despite intense pressure from the government to adopt growth driven policies. Global investors, who are extremely nervous at present in the face of issues facing China, Oil & Commodity driven economies and currency market volatility, view RBI under Dr.Rajan as a central bank that is in control of what it is doing.
The INR despite India’s improved economic position and RBI’s sound policies is down over 13% from highs over the last two years. The currency is facing headwinds from volatility in global currencies and volatility in oil prices that have plunged and then climbed sharply. Global currency volatility is the biggest cause of concern for the INR with sharp movements in the Yen over the last couple of months unnerving the market. Chart 1.
The INR is also under pressure from the outflows the country will witness in the second half of this year as FCNR B deposits mature. Read our note on FCNR B deposit maturity. RBI has covered for the outflows but volatility can be high until the actual maturity of the deposits.
The INR is currently trading at levels of Rs 66.90 against the USD. Since the time Dr. Raghuram Rajan took over as RBI governor, the INR has traded in a range of Rs 68.80, which was record lows seen in August 2013 and Rs 59 seen in May 2014. The INR is almost flat from levels seen in August 2013 and has fallen by 14% from highs. Chart 2
Dr. Rajan when he took over as the Governor of RBI from Dr. D. Subbarao, faced a huge challenge of extreme pressure on the INR due to global risk aversion on Fed stimulus withdrawal talks, high current account deficit, high inflation and falling economic growth. His immediate task was to provide stability to the INR, which he did by focusing on the internal strength of the INR. He changed the RBI inflation measure from WPI to CPI, raised interest rates to bring it in line with CPI inflation and floated a FCNR B scheme to attract USD deposits. The FCNR B scheme raised USD 34 billion and helped shore up foreign exchange reserves that had fallen sharply on capital outflows. Chart 3 shows the WPI-CPI spread and Chart 4 shows the movement in fx reserves since August 2013.
The RBI moves were widely seen as pragmatic by the global investor community, the INR stabilized and normalcy returned to markets. The country’s macros too strengthened with the help of falling oil prices that fell 50% in 2015 on the back of a global supply glut. Chart 5. India’s current account deficit fell from 4.7% of GDP to 1.3% of GDP over the last three years. CPI inflation came off from over 10% levels to levels of 5%. Fiscal deficit has come off from 4.8% of GDP to 3.9% of GDP.