New Guv may breathe easy on inflation

The government has at long last named a successor for Dr Raghuram Rajan at the Reserve Bank of India. But what are the major tasks before Dr Urjit Patel? Though a sound economist, Patel does not have an aura of global reputation rivalling Rajan, which overshadowed those of the political leaders. Removing Rajan was in effect dropping a hot potato.

Already outgoing Governor Rajan had indicated some of the immediate ones. While asked about the lowering of the interest rate during the last press conference after his monetary policy announcement, Dr Rajan had observed that he was leaving that decision to the next Governor. 

Surely, a rate decision might be the most immediate task. But that could be the least important for the time being. Dr Rajan had moderated interest rates several times last one year. His grouse had been that the bankers were not actually passing on the benefits of a rate cut to the borrowers. In fact, in a mild criticism, the outgoing governor seems to have suggested that the bankers were putting forward specious arguments for withholding transmission of RBI’s policy rate cuts. 

The government would, of course, expect further rate cuts, which it was asking Rajan to do repeatedly. The belief is that a rate cut should encourage growth rate at this point of time. The government wants to show the efficacy of their economic programmes by presenting a buoyant economy. This might have further political compulsions in the run-up to state elections in 2017 and 2018 and general election in 2019. 

There might be a point of conflict there with the Central government, as Rajan and his predecessor had earlier. While North Block actively expected the Central bank to cut rates, the Central bank dug in heels on inflation numbers. So the question would be: will Dr Urjit Patel be more accommodative to the demands of the Central government in the context of the latter’s political calculations?

There lies a difficult choice for Dr Patel. The intellectual edifice for Reserve Bank’s current “inflation targeting” was worked out by none other than Dr Urjit Patel. He was made the chairman of the committee which went into the issue of “inflation targeting” and it was he who set the exact inflation targets for monetary policy formulation – 4 percent, plus/minus 2 percent. 

He has been very much in the company of Rajan in his fight against inflation. As an economist, he is known to have a conservative view on the issue of inflation targetted by a Central bank.  Maybe, a conservative approach towards this might not be so much in conflict with the position of the Union government so long as he keeps out of making strong public statements on broader issues. 

Where the government became uncomfortable with Rajan, despite the latter having reportedly developed a rapport with the Prime Minister, was the strident observations on issues other than economic management. He had emerged as what has come to be known as a “public intellectual”. Rajan had often stated that the Central bank could not be a “cheerleader” for the government. He had also stated that no one needs to crow over India’s high growth rate when the rest of the world was languishing. His observation comparing the situation with a common Hindi proverb was not taken lightly by the government. Maybe, Rajan’s misfortune was that in our public discourse, the country had lost all sense of humour. 

Notwithstanding these sensitives, for Dr Patel inflation targeting should not be such a ticklish immediate concern. This is for two reasons: first, Patel is stepping in when inflation should stop being such a big spoiler of the party. Despite some pick-up in inflation last fortnight with consumer prices having reached highest in last two years, the overall pace of inflation might in fact slow down.

Indian inflation is sensitive to food prices and these have almost always shown softening trends between October and March of the following year. The winter seasons see a far better production of vegetables and fruits, sometimes ending in incidents of glut and these should drive overall prices down. With better monsoon this year, the prices should hopefully show distinct flattening from next month onward. 

Additionally, global prices of oil have also remained low and are expected to not rise sharply. With Iraq and Iran vying to raise their oil production and trying to capture larger slices of the global market and Nigeria promising higher production, the chances of any freeze in production is remote and oil markets expect the prices to remain depressed. 

Secondly, setting the interest rates would be much less a personal responsibility of the RBI governor from now on than previously. With the government and RBI agreeing to set up the monetary policy committee (MPC), setting the policy rate would be a collective responsibility of the committee than the governor. A decision on interest rates should be on the basis of voting in which RBI and government have equal numbers. So the recrimination could be put behind between North Block and Mint Street as witnessed sometimes. Thus, to kick off his tenure, Dr Patel can breathe easy on the domestic front. 

Where Dr Patel could face his biggest challenge and putting his foot into a big shoe left behind by Rajan would be in managing the external front.  Rajan had come in when the rupee was facing extraordinary volatility and was depreciating mainly because of divergence between the Indian onshore foreign exchange markets and overseas non-deliverable deals in Singapore and Dubai. The divergences in the exchange rates were putting pressure on the rupee’s exchange rates. 

Dr Patel has an excellent academic background, having been groomed in some of the finest academies like the London School of Economics, Oxford, and Yale. Patel might not have so much of an exposure to the working of the financial markets. Rajan, coming from the Chicago business school and a background of tracking financial markets, was better-equipped to handle the financial markets. He displayed this in his very effective tackling of the exchange markets for rupee in India as well as the informal overseas markets. 

We can safely expect tumultuous financial markets in the near future. With the Federal Reserve bound to take some decisions on rate hikes, Europe turning increasingly uncertain with Brexit and China managing its domestic imbalances rather tenuously, any of these could set off disruptive forces. Dr Patel’s test would be how he keeps the external headwinds at bay and maintains financial stability for India.