Former Reserve Bank of India (RBI) Governor, Raghuram Rajan on Tuesday said the biggest risk was a combination of rising interest rates and some "untoward action on trade."
“The great uncertainty is what happens with trade. If we have a trade conflagration in the next few months that could really hamper the global economy,” Rajan told CNBC, and added that it was important for India and China to maintain friendly relations and bolster economic activity.
Rajan also said the tariffs imposed by the US on major world economies posed serious risks to market stability and raised concerns about the repercussions of such activity on the world economy.
Q: I wanted to ask you, we seem to be talking quite a lot at the moment about possibility of the next recession when and if indeed it will occur and if it is likely to happen in the next 12-18 months. Number of years ago, 10-11 years ago you won’t have financial imbalances in the run up to the 2007-2008 financial crisis, something that you and I have discussed a couple of times before. What is the biggest risk as you see it right now?
A: I think at this point, the biggest risk is the combination of rising interest rates and some untoward action on trade. I think it is the perception that with all the leverage that is out there, the interest rates rising are already an issue that we will have to deal with but that is out there.
The great uncertainty is what happens with trade if we have a trade conflagration in the next few months, you know that could really hamper the global economy.
Q: Do you think that is likely? You have said before and you have been vocal about it that a win-win situation is possible as we move through this not purely rhetoric anymore between especially China and the US, do you see the chances for a win-win resolution increasing or decreasing?
A: The key question is whether these bargaining ploys, threats of levying tariffs etc result in real negotiation, which create that win-win situation or do entities, do players get locked in to positions, which mean they eventually have to carry out their threats in which case we are in the lose-lose situation.
The problem to some extent at this point is that people have put forward their offers in some sense.
We have to see if they reach a negotiation point where they can back down. Some of these situations can get out of control very quickly.
Q: We talk so much about the trade issue as in US-China context but I want to ask about India-China because when you think about when Prime Minister Narendra Modi first came into office, we talked about deepening in his engagement with the US and yet we have seen a bit of a pivot over the last year or so. India warming up to China, visiting in April, we just heard Modi talk about the need for better future in India and China work together. What do you think has prompted this calculation for the Prime Minister and whether in fact you think this is sort of a zero-sum as in the warming up the China for India comes at the expense of its relationship with the US as well as Japan and Australia?
A: I don’t think it need come at the expense of the relationship with these other countries. I do think there is benefit in India having a good relationship with China and vice-versa because these are two big countries that can do a lot of economic activity together.
I do think that one of the reasons the countries are trying to form better relationships with each other is because of the unpredictability of the US administration at this point.
There is a catalyst out there, which is pushing these countries to talk more together but I think the fact of their talking is a good thing both for the countries and for the world. It is not coming at the expense necessarily of relationships with other countries.
Q: We started off by talking about the risks that are facing the world right now, you specifically of course talked in detail about the risks of trade conflict, the other point that you mentioned which I would like to take you up on is that of interest rates, I think it is something we specifically focused on when it comes to what is happening with the US economy right now, what is your prediction first of all of what we are going to see in terms of rates in the US and what do you think needs to happen there?
A: I think the latest news suggests the US economy is actually strengthening, is doing better, is actually doing quite well for an economy in its 92nd year of job creation.
So my sense is the Federal Reserve is on a raising path, which it is not going to step off until it feels it is much closer to neutral and I think most people would say neutral is between 2.75 percent and 3 percent at the short end.
That means we are probably looking at 3 rate hikes this year unless something untoward happens in Europe or in some of the big emerging markets to create global turmoil but it has to be really bad in my view for the Fed to step off this rate rising path. Otherwise, I think they are going to wait, do what they have to do and then look around to see if they have done enough or they need to do more.
So my guess is certainly June appears baked in but probably one-two more this year after which the Fed may start looking around.
Q: Do you believe that there is a real risk of the 10-year yield in particular, we have been watching this market very closely surging above that 3 percent level in any major way and is that a major risk to growth anyway? We have obviously had yields above that level before in fact significantly above that level. What is the biggest concern when you look at the treasury yield, you talked about the biggest risk being something negative happening in the emerging markets of course but what about within the US economy itself?
A: There are certainly areas of very high leverage even in the United States. Certain parts of the corporate sector which are highly levered and as much as the interest rates, it is also the easy access to financing, the ability to refinance, to rollover debt which has been very important in the leverage over the last few years.
As interest rates rise, as people start looking at your capacity to sustain interest payments or debt service over time, the ability to borrow also becomes more fragile.
So my sense is the highly levered areas of the US economy may in fact become most stressed as these interest rates pick up both because it is picking up at the short end as well as if it picks up at the longer end.
But this is something that everybody knows. We know that there are levered entities and this is something that is going to happen.