Rajan warns of turmoil in mkts if unstable govt is formed

Reserve Bank of India ( RBI) Governor Raghuram  Rajan's next big worry  is  what sort of government will take over at the Centre in June this year.

His worries are not about whether he will continue at the RBI, considering he was picked by the outgoing Congress led-UPA government. It is extremely unlikely the new government will trouble him.  Rajan is concerned about the excessively high expectations financial markets have been displaying, almost taking it for granted that a Narendra Modi-led BJP Government will come to power and form a stable government.  

The stock market is  already riding high on this expectation. The Bombay Stock Exchange (BSE) Sensex, the barometer of the market , has already jumped by 5-6% in the last three months.

Asked about the possibility of next government being unstable , Rajan said  the moot point was that financial markets were anticipating a stable government and rapid policy action. "To that extent,  if the market  are disappointed, it will reflect on the stock market, perhaps on the bond market and perhaps on the foreign exchange market," he added.

Rajan did not tinker with policy rates in his monetary policy review  on Tuesday. The repo rate was left unchanged at 8% and cash reserve ratio at 4%. Rajan remained hawkish on inflation. One possible reason could be the possibility of inflationary pressure flaring up in the election months of April and May  as a lot of money will be spent by the political parties and candidates.  

This was the first of the bi-monthly monetary reviews under the new system adopted by the RBI. Earlier there used to be quarterly and mid-quarter reviews.

Global giants like Goldman Sachs , CLSA, the Japanese Nomura and others have  come out with reports predicting that the Narendra Modi led BJP will come to power. Modi's track record of governance and development in Gujarat has been a major trigger for the enhanced expectations.

The biggest buyers of equities are the foreign institutional investors (FIIs) who have been pumping in money anticipating a stable government. FIIs have pumped in close to $4 billion since January this year.

"We have to be prepared for some turmoil,"  said Rajan in case the new government proved unstable.

There could be a knee-jerk  reaction in the stock market if the verdict is a fractured one. This could lead to FIIs pulling out their money from the Indian market in the short term. This has severe implications for the rupee value against the US dollar,  as any outflow of dollars  would put pressure on the rupee. And if the rupee depreciates ,  the import bill will rise and so will inflation. In the  past, rupee depreciation against the dollar has been a major cause for inflationary pressure.

But Rajan also sought to quell excessive fears. "At the same time I believe that even if the government is not necessarily a stable one, provided any new structure shows appropriate concerns about the economy, fiscal deficit and so on, I would suspect that after an initial bout of  turmoil, there might be a reassessment which may be more positive," he said.

"Let's wait and see.  What we have to do is be prepared for whatever eventuality may occur and as I said before, the better the balance sheet we build for the country the more prepared we will be ( for any turmoil),"  he added.

Rajan has always been quite proactive  in anticipating events. He did it earlier too when the US was expected to announce reduction of its Quantitative Easing (QE) programme.  The QE was all about US government buying bonds and releasing dollars in the market to prop up its economy. Excess dollars were finding their way in emerging markets by way of investment in equity , the commodity and bond markets. The threat of QE withdrawal in September-October last year was expected to pull dollars out of many emerging markets like India.  

Rajan , however ,  managed to  attract US dollars to the tune of over $30 billion by way of swap facility in the FCNR(B) deposit scheme. The curbs on imports also worked. Today , the rupee has been  comfortably trading at 60 levels as against 69 against the US dollar 6-7 months ago.