Urjit Patel: Governor’s Rule

ON 4 SEPTEMBER, WHEN Raghuram Rajan demits office as Governor of the Reserve Bank of India (RBI), he will be succeeded by his quiet deputy. The person, who has seldom been seen in public delivering lectures or presiding over events, is usually to be heard only during the customary analyst and press conference after the central bank’s monetary policy announcements. Even then, he waits for the mike to be handed over.

Meet Urjit Patel, the quiet Deputy Governor in charge of monetary policy at the central bank. With wide experience in the private sector, academia and international financial institutions, Patel is first and foremost a macroeconomist. His mettle is about to be tested in what is one of the more stressful jobs in India.

Earlier this year, on 18 June, Rajan announced that he would be returning to his position at the University of Chicago when his term ends. Within no time, there was a storm of sorts with accusations that Rajan had been ‘forced out’. It was no secret that relations between the RBI Governor and sections of the ruling dispensation—Rajya Sabha member Subramanian Swamy being a prime example— were not exactly cordial. At the same time, the lack of trust between Rajan and the Government was not a secret. On the one hand, Rajan was one of the most outspoken RBI governors the country had seen. In speeches on different occasions, he commented on topics that were not related to central banking. On the other hand, the present Government—like any other in New Delhi—wanted the RBI to reduce interest rates to boost economic growth. The two teams, in Delhi and Mumbai, did not gel.

The intervening period—the two months between 18 June and 20 August—was one of intense speculation, with all sorts of motives being ascribed to the Government. As is usual, a number of names were bandied about as probable successors to Rajan. Even as it avoided any controversy on the subject, the Centre took a novel step—of appointing a committee to select the new Governor.

Among the financial regulatory institutions of India, the RBI is perhaps the only one with a history of some ‘arbitrariness’ in the process of appointing its head. Unlike SEBI, PFRDA and other institutions where a regular search is conducted before appointing a person to the top job, the RBI Governor’s position is never ‘advertised’. In the case of one recent governor, D Subbarao, the process was almost casual in its lack of formality.

In his memoirs, Who Moved My Interest Rate?, Subbarao notes that there was an informal interview with the then Finance Minister and an economist, where he was asked a couple of questions and then simply handed the job. There is no doubt that in that case, the appointment turned out to be very good, as Subbarao turned out to be a highly skilled crisis manager and helped take the Indian economy to safer shores when it faced an unprecedented global crisis.

This time, the Government changed the process of appointment— for the better—and did not take the bait of announcing Rajan’s replacement in haste and under pressure. Instead, it relied on an established panel, the Financial Sector Regulatory Appointment Search Committee (FSRASC). Headed by the Cabinet Secretary, this body has the Additional Principal Secretary to the Prime Minister as a member. In addition, it has two academic experts and a representative of the Finance Ministry. The FSRAC, which had earlier interviewed candidates for SEBI’s top post, shortlisted names for RBI and then sent its recommendation to the appointments committee of the cabinet (ACC), which is chaired by Prime Minister Narendra Modi. Patel’s selection was an outcome of this process.

Economist Vivek Dehejia says that Patel’s appointment shows that, “a process has been put in place”. “Candidates were vetted, a long-list prepared, followed by a short-list. This is how central bank governors are selected and appointed in advanced countries. There is no reason why India should not have followed this practice. In the long-run, this process of selection will enhance the credibility of the RBI Governor.”

IN CHOOSING URJIT Patel, the Government has made an interesting choice. For one, it has put to rest the speculation that it would want to choose a ‘pliable’ governor who would do its bidding. Patel is far from being anyone’s man. With a PhD in Economics from Yale University—which has one of the world’s more conservative schools of the discipline—and other degrees from University of Oxford and London School of Economics, the Governor designate is perhaps one of the few trained academic economists to be appointed to the job recently. (Rajan is a specialist in Finance).

Patel’s appointment also signals a degree of continuity at RBI. He was an author of a 2013 report that recommended that the Indian central bank move to a flexible inflation-targeting approach to manage inflation. The Urjit Patel Committee also recommended that RBI’s interest rate setting decisions be taken by a Monetary Policy Committee (MPC) and not the Governor, as currently practiced. At the moment, the Governor is given inputs on rate decisions by a Technical Advisory Committee that has internal (RBI) and external members, but its recommendations are not binding. Patel also recommended that the inflation target be set at 4 per cent, plus or minus 2 per cent. The Government accepted this recommendation earlier this month.

Patel’s academic work has mainly focused on fiscal policy. In a series of papers that he wrote with Willem Buiter—a professor at the London School of Economics at the time and chief economist at Citigroup later—Patel looked at the performance of the Fiscal Responsibility and Budget Management (FRBM) legislation in India through a comparative lens. The issue at hand was what would happen if the states or the Centre reneged on their fiscal deficit commitment—something that has happened in the past. Using game theory treatment, the two academics looked at what kind of incentives could be devised to ensure that the two ‘players’—the Centre and states—stuck to their deficit targets. Interestingly, in this paper written in 2010, the two suggested the involvement of the Judiciary as an arbiter in the process of keeping the states and the Centre in line.

Patel and Buiter noted that, ‘…it may be possible to have an incentive compatible framework with an inbuilt carrot and stick strategy that brings in the judiciary and thus integrates the central and state governments in a manner that holds them credibly accountable and, more importantly, rewards and punishes (enforces) each other’s fiscal performance.’

So, will the new RBI Governor be tough when it comes to the Union Government sticking to its fiscal promises?

“Some people call him a ‘fiscal hawk’… I don’t know what that means. Fiscal deficits will remain the centrepiece of any macroeconomic management strategy. But that does not mean that [Patel] will be unmindful of requirements of economic growth, particularly in an economy like ours. His fiscal concerns will not renege the concerns about growth,” says NK Singh, chairman of a committee constituted to review the working of the FRBM Act of 2003 (of which Patel is also a member).

“I first met him at the IMF when we were negotiating the first tranche of a loan in 1991,” Singh says. That period was one of the most stressful ones in India’s independent history, when the country was on the verge of bankruptcy. Patel was at IMF working on the India desk. “He was a tough negotiator and demonstrated his thorough knowledge of macroeconomics,” Singh says.

That reputation for knowledge and toughness precedes his latest appointment.

Once Patel takes over, it would perhaps be the first time in time in almost eight years (and three RBI governors) that there are no macroeconomic clouds on India’s economic horizon. After a year or two of mistrust between the RBI Governor and the Finance Ministry team, Patel will begin with a clean slate. In Delhi, Hasmukh Adhia, the financial services secretary, and his colleague Shaktikanta Das, secretary, economic affairs, are busy preparing for the rollout of the Goods and Services Tax, a planned change in the fiscal year and other programmes. In Mumbai, Patel similarly begins with a rather benign economic outlook (even if inflationary pressures are never distant in India).

This brings its own set of challenges. While what comes to most people’s mind are interest rates and growth, there are other— more pressing—issues at hand. Says Dahejia, “Just to pick up the baton from where Raghuram Rajan left is one matter. There is a long list that awaits Patel. First, he will have to establish credibility with financial markets. Then there is the big problem of Non-Performing Assets (NPAs) of banks and bad debts that needs to be sorted out. Signalling policy continuity is another issue. Finally, and perhaps most importantly, there is the matter of the MPC of the RBI.”

The MPC is a six-member committee that includes the Governor of the RBI, the deputy governor in charge of monetary policy, and one RBI official. The three other members are to be nominated by the Government. At the moment, only two are in place: Patel (who will now be a member in his capacity as Governor) and the RBI official nominee, Michael Patra. There are four vacant positions to be filled before the MPC can start deliberations.

“In many ways, the credibility of the inflation-targeting framework depends on the credibility of the MPC,” says Dehejia.

His words are echoed by Singh, who adds that, “the need for continuity and making the MPC and the inflation target work in harmony with the overall fiscal stance of the government” is one among the immediate challenges facing Patel. Singh adds another issue that the incoming Governor will have to face: “The tight rope balancing between disclosure of NPAs while not giving a shock to the system, followed by orchestrating the repair of bank balance sheets [in accordance] with international norms.”

One private sector economist, who does not wished to be named, does point to a somewhat tricky situation that could confront Patel soon. From September to December this year, an outflow of up to $24 billion is expected due to the maturing of Foreign Currency Non-Resident (FCNR-B) deposits maturing during this period. This is money that was ‘invited’ as debt investment from NRIs in the summer of 2013 when the rupee was falling and the country’s foreign exchange reserves were going down. The attractive terms offered ensured an inward surge of dollars. While the RBI has ample reserves at hand to fulfill India’s obligations, the effect these repayments will have on liquidity conditions in the currency market as well as the banking sector could spill over into other markets. “There are no economic reasons to worry about—India has plenty of forex reserves and its fundamentals are strong—but the scale of forex outflows is such that some level of anxiety is natural in markets,” this economist says. Market participants add that in the natural course of events, this should hardly be a reason to worry at the stage of economic development that India is in (strong growth and a big chest of forex reserves). The challenge could be communicating with markets.

In contrast with Rajan, Patel is known as a reticent person. Given his mould of a classically trained economist, this should not matter. But these are unusual times in an unusual world where economic anxiety among market participants needs to be assuaged, continuously, by central bankers.

Given the relative economic quiet of the moment, perhaps Patel will also address some medium-term challenges. Dehejia says one such need is the development of a deep corporate bond market, which is essential for funding infrastructure and other projects with long gestation periods. Because such a market does not exist in India, companies are forced, willy-nilly to go to banks for their long- term financing requirements. This ultimately leads to the problem of big NPAs of the kind that are being seen in India today. On his part, Singh, among other issues, lists the challenge of converting high economic growth rates into rural demand—the sector that still employs a very large fraction of the country’s population but with a dwindling share of national output. This, in turn, is linked to the problem of reviving private investment in India.

That is a pretty long list for calm times. But such are the complexities of macroeconomic management.

Indian economyinflationinterest rate cutpoliticsRBI GovernorReserve Bank of IndiaSubbarao