At the height of the “taper tantrum”, the U.S. Federal Reserve sought tighter monetary policy whose impact was seen in massive capital flows out toward B.R.I.C.S., the volume of capital flow was staggering evidenced in India’s incipient balance of payment crisis; this was when Dr. Rajan entered the picture and opened up the foreign currency non-resident bond. This was a smart monetary scheme assisting a specific equity class need in forex carry trades. It worked. While the rupee fell, and inflation was imported, Dr. Rajan (trained under Milton Friedman at Chicago) organized an informal inflation target restoring calm immediately.
Although commodity prices have fallen considerably, Indian inflation has been halved. This is significant given that most of India’s inflation is linked to its agriculture sector. With an Asian drought haunting most Pacific political economies, India’s tamed inflation rate is welcomed; India still holds the highest rate in Asia. Nevertheless, structural rigidities throughout this large polity is the key to understanding Indian inflation.
Dr. Rajan’s positioning throughout these fraught scenarios is quite significant, for he asked his opposing political camp (Modi’s BJP) for incremental reforms. He resisted removing capital controls while managing rupee volatility, and he demanded ethical accountability from an entire political banking class. This isn’t the sort of voice the Indian “establishment” is used to dealing with; hence the hand wringing leading to his removal yesterday as Governor of India’s Central Bank.
It is this self-inflicted wound that may cause India irreparable damage. A Rexit isn’t something that India’s political class should take lightly. In the next several weeks New Delhi’s dominant political class with either demonstrate hardened tactical maneuvering to sustain international damage or this will be a permanent fault line hindering the operational tempo of Modi’s BJP.