Urjit Patel's First Policy Outing Marks A U-Turn From Raghuram Rajan Stance

With the economy growing in excess of 7 percent, most economists had predicted no change in the benchmark.

05/10/2016 9:28 AM IST | Updated 05/10/2016 9:36 AM IST
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Urjit Patel, governor of the Reserve Bank of India (RBI).

It was meant to be independence day for India's central bank. It might instead be viewed as mission accomplished for Prime Minister Narendra Modi's government.

With a new governor at the helm of a newly-minted Monetary Policy Committee, the bank had the opportunity Tuesday to buttress the autonomy over interest-rate decisions that former leader Raghuram Rajan fought for. With the economy growing in excess of 7 percent, most economists predicted no change in the benchmark.

Instead, Reserve Bank of India Governor Urjit Patel surprised many with a rate cut, signaling that faster expansion has become the priority even as inflation remains stubbornly higher than in the rest of Asia. Three government-appointed economists and two RBI colleagues joined Patel in a 6-0 vote in favor of the quarter-point move. They acted hours after a top bureaucrat highlighted the government's view that inflation is receding.

Offering no sign that Tuesday's action was a one-and-done maneuver, Patel's first policy outing marks a U-turn from the stance adopted by Rajan -- who repeatedly faced down government pressure for lower rates. The cut also contrasted with Patel's own role in Rajan's successful campaign to secure an inflation-targeting regime, which was among the biggest changes to the RBI's governance in its eight-decade history.

"Markets will look at this decision as signaling what the priorities of the new governor will be," said Mark Williams, chief Asia economist at Capital Economics in London. "The answer seems to be supporting growth even at the risk of missing targets for inflation. That's a break from the more hawkish stance of Mr. Rajan."

India's sovereign bonds rallied after the rate decision. The yield on notes due September 2026 plunged five basis points to 6.72 percent in Mumbai, the lowest for a benchmark 10-year security since June 2009. The rupee advanced 0.2 percent at 66.46 a dollar.

The RBI explained the decision by citing cooling food prices and weak global demand. Patel also cited the U.S. election as a source of uncertainty -- with anti-trade Donald Trump still in contention against Hillary Clinton. Patel did meet expectations on one front: his reputation for eschewing much public communication was borne out by a brisk press briefing, which he called to an end after about 15 minutes, saying he had a "tight schedule today."

Government officials have made clear their preference for lower borrowing costs. Economic Affairs Secretary Shaktikanta Das said in an interview with ET Now television that inflation had moderated considerably, backing up previous remarks by Finance Minister Arun Jaitley who had urged lower rates. In late August, Commerce Minister Nirmala Sitharaman called for a 2 percentage point cut.

The RBI lowered its benchmark rate to 6.25 percent from 6.50 percent, the lowest since January 2011. Only 16 of 39 economists surveyed by Bloomberg News forecast the move.

While Patel and his colleagues didn't rule out any further shift, the new MPC may still be wary of further reductions should price pressures rise again.

"Inflation is a massively political issue in India," said Gareth Price, a senior research fellow at The Royal Institute of International Affairs, also known as Chatham House, in London. "Elections have been won and lost over the price of onions."

Under the deal struck with the government, the central bank aims to keep consumer price inflation at four percent through 2021 while allowing the rate to fluctuate in a 2 percent to 6 percent band.

The controversial end of Rajan's tenure in a bout of nationalist rhetoric left Patel, a deputy to Rajan who had led his initiative to establish a new panel to oversee policy, in a tough place. Patel's past work in Gujarat when Modi ran the state only reinforced an image of a successor who'd be closer to the government. Patel had previously served on the board of a major state-owned enterprise in Gujrat.

While Rajan sought to institutionalize the Reserve Bank's independence, through establishing the formal inflation target and the new panel, it was ironically his own character and actions that contributed most to establishing autonomy for the RBI while he was in charge.

The former International Monetary Fund chief economist had already garnered global standing with a memorable presentation at the U.S. Federal Reserve's Jackson Hole conference, in 2005. Once in office, he became a gadfly for tycoons, bankers and politicians, speaking out on topics ranging from corruption to religious tolerance. He also regularly weighed in with thoughts on how his counterparts in the richest nations were conducting monetary policy.

Rajan was prepared to hold off on cutting rates when the inflation rate was falling. That helped garner him a reputation as an independent actor in an environment where government officials feel free to speak out regularly on the RBI. Under Indian protocol, the governor ranks below members of the Cabinet.

Patel brings a much different background, despite having also had a stint at the IMF early in his career. With roots in Modi's home state of Gujarat, he is seen as more aligned with Modi's Bharatiya Janata Party.

To be sure, suspicions of political pressure aren't the only reason for the RBI cut. The nation's growth rate is slowing amid weak investment and consumption and geopolitical tensions with neighboring Pakistan are weighing. The IMF on Tuesday tipped India's growth in 2017 to remain the same as this year's -- still the highest forecast among major economies at 7.6 percent.

There were other signs too that Patel is softening the previous regime's stance, hinting he may take a different approach to a $120 billion bad-debt clean up that has cut bank profits and slashed bonuses. Patel urged "firmness but pragmatism" in bad-debt clean-up efforts, and said the RBI will deal with the bad loan situation so there is no shortage of credit in the system.

Taken together, the onus will remain on Patel to ensure investors retain confidence that the bank is above political interference.

"It will be vital to show that the central bank has credibility in its inflation fighting

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