We are all waiting for the consequences of Brexit to unfold. Clearly the vote to "Leave" caught most pundits, media, politicians - the elites - on the wrong foot. What is also clear is that there will be much turbulence in international finance as uncertainty builds.
When the Indian government decided that Dr. Rajan need not stay on for a second term, the conventional wisdom was as follows:
When the Indian government decided that Dr. Rajan need not stay on for a second term, the conventional wisdom was as follows:
- Energy prices were expected to stay depressed for an extended period of time, and would give India the relief it needed in terms of trade deficits and exchange rates.
- India's reputation had surged over the last 12 months as the lone attractive investment opportunity among the BRICS. This would attract the much needed investment for Make Ind India.
- A "normal" monsoon was expected, which would put a cap on the prices of agricultural commodities and hence inflation.
Dr. Rajan had led RBI creditably, demonstrated political independence, and restored a degree of monetary prudence and credibility to India. Challenges still remained, but India appeared to be on the mend thanks to the steady hand of Rajan, and a pro-business and pro-investment agenda of Modi and the BJP.
I would posit that Brexit has thrown a spanner in the works. I believe that in the coming years there will be remarkable fluctuation in investment flows, exchange rates, and speculators probing the stability of a host of currencies.
As the Brexit drama unfolds with possible "LEAVE UK" initiatives in Scotland and Northern Ireland, a whole host of industries in the UK will see delays in incremental investments. New projects will be put on the back burner. The uncertainty will have a cascading effect in Europe which finds itself in a bear trap of negative rates and perpetually depressed regions of Southern Europe. The engine of European growth - Germany - will oppose large monetary easing and rescue packages. Growth will slow down further in the EU zone. Whether the EU as we know it unfolds, only time will tell.
The impact of slow growth in the EU will be felt most acutely by the global engine of growth - China. With overcapacity in multiple sectors, and a bloated and debt ridden state sector, there are no easy options left for China. Short of a deep devaluation of the Yuan, China is looking at a further slowing of its economy. Devaluation of the Yuan will come at a cost - placing a huge burden on debt servicing denominated in foreign currency. Bankruptcies could happen on a scale that China has never seen. Social upheaval, and the channeling of anger into hyper-nationalist causes is a likely outcome.
A devaluation by China will likely spark a whole host of devaluations by other developing countries to maintain competitiveness. We will also see new protectionist barriers to stem the flood of Chinese goods.
While oil prices are expected to stay low as the world economy slows, terrorist incidents in the Middle East could lead to major spikes. The bonanza from low oil prices could be short lived.
On the local front, a "normal" monsoon in India is far from certain. Inflation has started to rear its ugly head. While India has adequate agricultural stocks, its ability to store and distribute them efficiently has always been a weakness.
Given all this, what India needs is an RBI governor such as Dr. Rajan. He is regarded as one of the most competent central bank governors at the present time. It is a colossal mistake for Dr. Rajan to be allowed to bow out from the scene at this critical juncture.
Mr. Modi, Winter is Coming. You need Dr. Rajan on the India team.
