The Rajan Effect

The effects of the fact that Raghuram Rajan, the RBI Governor designate, is due to takeover from Governor D. Subbarao, have already begun showing. Raghuram Rajan is currently Chief Economic Advisor in the Finance Ministry. He will be taking charge from D. Subbarao from 1^st September, four days earlier than scheduled.

Raghuram has already started interacting with the RBI team and has already effect a few policy changes. First came the slight easing in liquidity for banks by injecting Rs.8,000 crore into the system. This would aid wholesale funded banks like Yes Bank, InduSind Bank, etc. Then came a bigger step – the change in guidelines for restructuring infrastructure loans. The RBI will change the restructuring guidelines of infra projects by allowing a one-time restructuring in the life of a project delayed due to extraneous reasons, such as delays in land clearance, environment clearances, fuel linkages, etc. This can now be done by the banks, without provisioning for restructuring such loans, on a one-time basis. Thereby it is likely to reduce NPAs of banks, and, more importantly, unlock projects worth Rs.1,60,000 crores, which are stuck in clearances. This will also allow banks to increase the tenure of the loans for one time, without provisioning. Raghuram also seems to have the backing of D. Subbarao for these measures. It is D. Subbarao who will himself announce these guidelines within the next couple of days.

This will also unlock huge liquidity of the public sector banks. The only thing is that the government will now have to move quickly on removing bottlenecks for such projects, to complete the reforms and kickstart growth, which the Cabinet Committee of Economic Affairs (CCEA) is aggressively looking to clear case by case, and is also likely to happen quickly.

The next big leap for Raghuram Rajan would be to signal the reversal of the long term interest rates cycle, while keeping short term rates tight. He would have to begin lowering interest rates, with a 25 bps cut, sooner rather than later, and then gradually announce more rate-cuts. This he is likely to do, once he takes over.

A reversal in the long term interest rate cycle and a stable currency will then be sufficient to bring India back to the growth path, although from hereon it will be an uphill climb for growth to claw back to the 6 percent mark. Therefore, one can expect stock markets to remain volatile for three to six months, also considering QE3 tapering is now certain to begin sometime in September or October.

It will be interesting to see how Raghuram handles this event, when it does happen. Most of QE3 tapering already seems to have been priced into the stocks markets and the currency depreciation, but it will definitely cause volatility when it actually happens.

However, I believe that the ex-IMF heavyweight Raghuram is capable of handling it much better than Subbarao, given his youth, experience in IMF and infusion of fresh, innovative  ideas.