The Modi government's decision to appoint Urjit Patel as the next Governor of the Reserve Bank of India (RBI) debunks the popular myth that the outgoing Governor, Raghuram Rajan, has been elbowed out due to differences over interest rate policy. If anything, Urjit Patel is more of a hawk on inflation than Rajan, having authored a report that specifically asked the RBI to focus on bringing down consumer inflation. This should set at rest the market's fears that Rajan will be replaced with a dove who will bring down interest rates too soon; it will also quell anxiety within the RBI that the Modi government may foist someone on it who will rock the boat. Patel is now an RBI insider, and has been with the bank since January 2013. There will be continuity with change.
Despite the nasty outburst by Subramanian Swamy, the maverick Rajya Sabha MP who launched a diatribe against Rajan alleging that he was "mentally not fully Indian" and that he had "wrecked" the economy, the fact is Swamy was not the man who precipitated Rajan's exit. It was Rajan himself. The reason why Modi and Arun Jaitley let Rajan go probably relates to the latter's outspokenness. He had a tendency to lob barbed comments with a political content, which a gleeful anti-Modi English language media feasted on.
Nowhere in the world do central bank governors offer red meat to the media that can embarrass the government of the day, but Rajan did precisely that by references to "Hitler" and "one-eyed kings". He also dissed the Modi government's Make in India initiative, advocating Make forIndia, as if the two are diametrically opposite ideas. You can Make for India by Making in India. Though Rajan's observations could have been explained away as having their own specific contexts, the Governor showed no political sensitivity when the media made a meal of his comments and used them as sticks to beat the government with.
Given this background, Urjit Patel is the right replacement for Rajan. He is likely to focus on monetary policy and economic issues, steering clear of quasi-political opinion-mongering. Patel has maintained such a low profile these last three-and-a-half years, that he fits to a 'T' the Modi government's preference for appointing people who keep their heads down, work quietly, and don't make waves in the media.
The question that arises with the appointment of Patel is whether we are going to see any major change in the conduct of monetary policy.
The short answer is no. As the author of the idea that the central bank must target retail inflation and not growth or exchange rates, Patel is not now going to take a different line. The four percent target for Consumer Price Index (CPI) inflation (plus or minus two percent) is now set in stone, as the NDA government has signed up to extend the agreement with the RBI for the next five years.
The big change will not be in the direction of monetary policy, but how it will be decided.
Reason: the next monetary policy, due in October, will probably be decided by a Monetary Policy Committee (MPC), in which the Modi government will have a large say. This is because the committee is to have six members, three from the RBI, and three from the government, with the Governor being one of the RBI's three. He has a casting vote only if there is a tie.
But here's the interesting point: with Urjit Patel being elevated, the government actually has the opportunity to appoint a Deputy Governor in his place, and this means it could, if it wanted, have four people of its choice in the new MPC. In the short-term, at least, the government has the upper hand in the MPC, though government appointees usually tend to gravitate towards the RBI's own line in due course.
So, the chances are the first MPC will maintain status quo, but with a dovish stance that will lower rates at the first opportunity.
One of the criticisms levelled by the government's critics is that it has, by deciding not to give Rajan a second term, damaged the RBI's autonomy. The reality is the opposite; RBI governors have always had institutional autonomy despite many Governors being former Finance Ministry officials (Bimal Jalan, YV Reddy, and Duvvuri Subbarao, among others, with Rajan himself having come to Mint Street after a stint in the ministry as Chief Economic Advisor).
It can, in fact, be argued that the RBI Governor's power comes from being non-political, and not by exercising his right to free speech in a way in which the government of the day is embarrassed. Extending this logic, it means Rajan's tendency to express an opinion on many subjects may actually have come close to compromising the RBI's autonomy. In that sense, Patel is the right antidote.
To be sure Patel will face the usual pressures from India Inc and the finance ministry to cut rates, but this is par for the course. All RBI Governors have faced this, and few succumbed. Patel won't too.
His real challenge is to prove that inflation targeting, of which he is a votary, is worth it.
The RBI's role is to signal trends in inflation, but it does follow that it can successfully target inflation, especially in a country like India where the roots of inflation lie in food prices. Food inflation, apart from being determined by the monsoon, is more amendable to control by the government, since it is impacted by minimum support prices (MSPs).
Even in the West, central banks have, after the Lehman crisis, been using near-zero interest rates to target a certain level of inflation, but have largely failed. The US Fed, the European Central Bank and the Bank of Japan have all flopped miserably in pushing growth or inflation. On the contrary, they have stoked asset price inflation (stock and bond prices) by their zero-rate policies. Now they are trying negative interest rates – the ultimate sign of bankruptcy in monetary policy-making.
When it comes to deciding what impacts inflation – on the up or down side – fiscal policy has more tools than monetary policy. So hanging the inflation albatross around the central bank's neck is questionable. India's double-digit inflation under UPA-1 was the result of loose fiscal policies after 2008, and very high MSP increases in the run up to the 2009 elections.
Rajan's rate hikes in the initial months of his tenure are credited with bringing down inflation, but retail inflation was already on a downward trajectory by the time he was taking over in September 2013. His rate hikes, however, may have helped lower inflationary expectations, but inflation itself was down because of the fuel price collapse in 2014 and the NDA's restraint in raising MSPs.
Urjit Patel is a safe choice for Modi, both in terms of credibility and politically. He is unlikely to bring down rates too soon, but that may not matter much since banks anyway are not passing on rate cuts in full to borrowers. Of the 150 basis points cut in the repo rate so far from the peak levels of January 2014, just about half has been passed on. Rate cuts "door ast."