'Rockstar' Rajan to step down

The internationally-respected head of India's central bank, 53-year-old Rajan, is lauded for effectively steering the Indian economy and controlling runaway inflation after he took over the job in 2013.

This was a time when the nation's economy was in poor shape, with a burgeoning trade deficit, soaring inflation and concerns over worsening fiscal position.

But under his watch, India's currency has strengthened and foreign-exchange reserves have surged to an all-time high. India is now regarded as the world's fastest growing major economy, with growth in 2016 expected to be over seven percent.

However, Rajan's refusal to cut interest rates rapidly for fear of stoking inflation and his tough stance on cleaning up India's troubled state-controlled banks, have been disliked by sections of India's business and political elites - including some within Prime Minister Narendra Modi's ruling Bharatiya Janata Party (BJP).

Willingness to speak out

Unlike his predecessors at the RBI, Rajan has also frequently spoken about issues beyond monetary policy, such as corruption. His comments, say observers, are often seen as critical of the Modi government.

Furthermore, the governor has questioned government policies, suggesting that the Modi administration was making a mistake by trying to ape China's export-driven manufacturing economy, and that it was trying to open bank accounts for the poor too fast without making sure they worked for the beneficiaries.

In contrast to Modi's efforts to project the Indian economy as doing very well, Rajan has repeatedly cautioned that being the world's fastest growing large economy was not enough.

The central banker has even questioned the Modi government's new methodology of calculating India's GDP growth rate.

As a consequence, Subramanian Swamy, an extreme right-wing member of Modi's BJP, recently launched a flurry of attacks on Rajan, asking the prime minister to sack the governor. Swamy alleged that Rajan was "mentally not fully Indian" as he holds a US Green Card and that the central banker was wrecking the economy.

Impact on sentiment

Against this backdrop, speculation had been rife about Rajan's future at the RBI, with reports claiming that the government was looking to let him go following the end of his term in September.

RBI governors are usually given a three-year term followed by a two-year extension.

But the government's tepid distancing from Swamy's comments, say some analysts, was the reason behind Rajan's announcement on Saturday, June 18, not to continue at the RBI.

Unusually for the post of India's top central banker, the issue of Rajan's exit became political, making front-page news every other day. Rajan hinted in his note to RBI staff that he may have stayed on, and that he was leaving only "on due reflection and after consultation with the government."

That Rajan made his announcement on a weekend helped ease the impact on India's stock markets, with a general consensus that any negative impact stemming from the departure would be short-term. Nevertheless, the biggest effect will be on investor sentiment.

Rajan is highly regarded among the global investor community, not least because he was one of the few economists who accurately foresaw the systemic risks resulting from innovation in the financial sector, which would eventually cause the 2007-08 global financial crisis.

This is why his resignation is likely to put financial markets under pressure in the near term, Shilan Shah, India economist at London-based Capital Economics, wrote in a research note.

"Once the dust settles, however, the long-term impact on markets will depend in large part on who replaces Rajan," Shah said. The government has stated that a successor will be announced "shortly."

Tackling tough issues

Nevertheless, analysts say Rajan's departure reflects poorly on the Modi government.

"Modi's government seems to value commitment above competence or credibility. This is bad news for India's institutions. Rajan has worked to set hard targets for a bank clean-up. It's not certain his successor will be as tough. The stability of the Indian economy is dangerously dependent on the confidence of foreign investors. Rajan's exit will shake that confidence," says Mihir S. Sharma, author of Restart: The Last Chance for the Indian Economy.

The ballooning size of bad loans among India's public sector banks has become a worry for the economy. With Rajan cracking down on the banks to clean up their books, pressure has been increasing on businesses that owed banks money.

Experts hope the Modi government will not ignore the problem of bad loans and that Rajan's successor will continue to push the clean-up drive.

"The genie is out of the bottle, and that may be Rajan's biggest contribution to cleaning up the banking sector that has become the epicenter of crony capitalism," says Samir Saran, president of the Observer Research Foundation, a New Delhi-based think-tank.

"The impact of Rajan's exit may depend on the quality of the new candidate. India has had a tradition of very strong and prudent central bankers and it is hoped that that would be the case going forward," Saran noted.