Urjit Patel and the inflation battle

At first glance, the Modi Government has earned some credit for ensuring a degree of stability in the conduct of monetary policy by selecting the highly accomplished Dr. Urjit Patel, Deputy Governor, to succeed the internationally acclaimed Dr. Raghuram Rajan to head India's Central bank.

This development needs to be watched in the light of past run-ins between Government and RBI on the latter's monetary policy stance from time to time in a context of growth-inflation dynamics, also impinging on the degree of independence that the Governor heading the country's most prestigious institution - the Central bank - has traditionally enjoyed.

By the selection of meritorious Dr. Urjit Patel, Government has saved itself from adding to embarrassment, had it opted for a different person who could perhaps be viewed as one more likely to toe the Government line. Dr. Patel, as suggested by Dr. Rajan in September 2013, set up a panel of experts and came up with a revised and strengthened monetary policy framework with a CPI inflation benchmark.

Whatever the circumstances leading to Dr. Rajan stepping down on September 4 preferring to return to academia, Dr. Rajan and Dr. Patel made a unique combination in working on a guide path to lower inflation hobbling a steady growth of the economy.  Dr. Rajan calibrated the monetary policy with aplomb over three years, maintaining an accommodative stance amidst lowering CPI but continuing inflationary expectations.

India's monetary policy management overall has been widely rated as successful. Now, given the understandable concern of the Modi Government over the lack of job creation in the economy over last two years - irrespective of more important structural and supply-side issues it is tackling - it would still look to monetary policy as a key stimulus for growth.

What has now brightened the outlook for a well co-ordinated fiscal and monetary policy moving in tandem is the new framework agreement between Government and RBI with a CPI inflation benchmark at 4 percent plus/minus two points. Under this framework, a six-member Monetary Policy Committee (MPC) will frame the policy from time to time so that  decisions would become collective instead of coming from an individual (Governor). The government has already notified the MPC to which it would nominate three members soon. Besides the RBI Governor who will chair, there would be two other RBI nominees including the Deputy Governor in charge of monetary policy. The Governor will have a casting vote. 

The first meeting of MPC is likely to be before October 4, the date set by Dr. Rajan for the next policy review, in his last bi-monthly policy statement of August 9.  The key lending (repo) rate now stands at 6.5 percent after having been brought down by 150 basis points by Dr. Rajan since January 2015.

But CPI inflation and WPI inflation in July had soared above expectations, according to official data announced after the last Policy Review. When it holds its first meeting, the MPC would also have the August inflation and other relevant data as it takes an overview of all macroeconomic trends.  A preliminary assessment of Kharif crop prospects post-monsoon should also be available by early October.

While India is well-positioned to withstand any global shocks and has built up reserves of the order of 365 billion dollars by the first week of July, policy-makers would have to take into account weakening global growth and instability in financial markets. Monetary policies in major economies have also been undergoing frequent changes with their effects on inflow and outflow of capital.

After waiting several months since it began withdrawal of monetary accommodation in the last quarter of 2015, the US Federal Reserve is now expected to announce its second rate hike in October, taking note of improved employment data and other fundamentals in the American economy. The Federal Funds rate had been held at near zero levels for over eight years since the outbreak of the global financial crisis in September 2008.  All said and done, Dr. Patel takes over his heightened responsibility in the midst of challenges at home and in the world economy. His reputation has been one of no less an inflation fighter. Equally strong is his view on fiscal deficit control in the fight against inflation. He is said to be the brain behind the 3 percent fiscal deficit target.

Yet, senior officials in Finance Ministry are voicing hopes that Dr. Patel would also "balance the requirement of growth as mandated in the amended RBI Act".  Another factor associated with his selection relates to his nature of being, unlike Dr. Rajan, far less outspoken on a range of issues he would come up against thereby perhaps avoiding too much discomfort for the Government.

In Dr. Patel, leading economists see the required abilities to keep inflation under control, also taking into account growth, though visible growth would result only when inflation gets stabilised at as low a level as possible within the targeted range. Several determining factors would come into play by the time the next monetary policy review gets announced both in regard to inflation (if demand picks up) and output trends.

One of the immediate tasks of the new Governor is to ensure a smooth redemption in NRI debt of the order of 20 billion dollars. This should not cause any big worries for the market. The banking sector will get major attention but whether the process of cleaning up of balance sheets of banks with varying magnitudes of non-performing assets would be completed by March 2017, a target set by Dr. Rajan is unclear. These issues should soon be got over for the revival of credit growth. Any cut in the policy rate in the near future would also be linked up with progress on stalled projects and Government's supply side management with regard to food prices, especially relating to cereals and pulses and sugar and other bottlenecks hampering growth.

With his elevation underlining a broad continuity of policies of Dr. Rajan to which he had contributed a great deal, public expectations and assumptions globally are that Dr. Urjit Patel would not compromise on his reputation as a monetary economist and would regard bringing down inflation as his first charge. IPA