India, Replacing Rajan
India has become one of the fastest-growing economies in the world. The country’s economic growth of 7.6% over the 12 months to the end of April puts it ahead of China’s official figure of 6.7%. This has attracted investors who have sent the Indian Sensex index up by 60% over the past five years, comfortably ahead of the FTSE 100’s 39% gain, and the paltry 2% gained by the MSCI China index.
Prime Minister Najandra Modi was elected on a business and reform ticket and has had some success albeit with political obstacles slowing progress more recently. However, considerable credit has to be given to outgoing central bank governor, Raghuram Rajan.
Mr. Rajan has been responsible for managing inflation, which has fallen to 5.8% (as of the end of June) from 12.2% in November 2013. This improvement has been achieved through the implementation of interest rates that have constituted a form of medicine that has been too unpleasant for many politicians. As a result, the renewal of Mr. Rajan’s tenure was not supported, and he will leave at the end of his term in September. However, the positive economic legacy that Mr Rajan leaves is not confined to inflation.
Foreign exchange reserves, a measure of a country’s external assets including deposits, bonds and gold, have reached near record levels of more than US$360bn after being at US$245bn when Mr. Rajan took on the role of central bank Governor in September 2013.
A further issue that Mr. Rajan had begun to make progress with was that of unpaid loans in India’s banking sector, amounting to around $100 billion. The origins of this problem lie in the corporate investment binge of 2003-2008, which resulted in overcapacity and over-extended balance sheets. State banks, in particular, were instrumental, lending excessively to infrastructure and steel companies for unprofitable road projects, power stations and factories. Many of these loans were not subsequently repaid in full, or at all. As a result, the banks reduced lending to all companies, including healthy ones in need of funding. By September last year, stressed loans accounted for 14% of the total assets held by state-backed banks. This compares to 6% in 2011.
In February 2016, Rajan announced “deep surgery” on the sector, in an effort to clean up the banks’ balance sheets. He has forced the country’s lenders to conduct reviews as the first step towards identifying and dealing with these loans; by the end of March next year, they must make provisions for all of the troubled assets on their books. The Reserve Bank of India is also putting pressure on corporate borrowers to repay their debts, a long and painful process that is unpopular with some of the country’s most powerful businessmen.
Finding someone to follow Mr. Rajan is a significant challenge. As a top-level academic and former Chief Economist at the International Monetary Fund, he is of the highest calibre. But, more than this, he also demonstrated the strength of character to stand firm in the face of populist political pressure. Bearing in mind that this strength of character cost Mr. Rajan his job, the chances are that the next Governor of the Reserve Bank of India could be selected at least in part on political acceptability rather than purely financial prowess.
The temptation of the next Governor might be to lower interest rates too quickly, but this would run the risk of stoking inflation which could cause long-term economic problems and undo the good work done to date.
Reasons for optimism
However, the new Governor will step into an environment in which an independent monetary policy committee sets interest rates, reviews bankruptcy rules and is supported by legislation and a supposedly reform-minded Prime Minister.
There is some risk that India could squander its hard-won gains. However, it can be argued that India’s recent success is the result of the work of more than just one man. A senior government official told Reuters, the news agency, that the list of contenders for the role has been shortened to four names: Urjit Patel, who is currently serving as Deputy Governor; Rakesh Mohan and Subir Gokarn, who have both held the number-two spot in the past; and Arundhati Bhattacharya, the chair of India’s biggest bank.
If this list is accurate, it means Prime Minister Modi has a strong pool of potential Governors to choose from. With its central bank in capable hands, we think India could continue to provide good investment opportunities in coming years.
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