Reserve Bank of India Governor appointed: New model or Rajan 2.0?

22 August 2016

Deputy Governor Dr Urjit Patel has been promoted to Governor of the Reserve Bank of India (RBI). While normally it is a case of “be careful what you wish for”, we are cautiously optimistic about the appointment.

The outgoing Governor, Dr Raghuram Rajan, was quite rightly voted Central Bank Governor of the Year for 2016, with credit also going to his team.  The fact that his deputy is being promoted to the top position of the world’s fastest growing economy gives a clear indication that Prime Minister Modi is intent on a smooth transition and more importantly a continuation of the monetary policies implemented by Rajan.

Patel and Rajan share a remarkable number of similarities.  Both were born in 1963 and completed doctorates at US universities. They have both worked at the International Monetary Fund (IMF) and importantly, their economic views are described as hawkish.

The choice of Patel also has greater significance than the appointment itself.  It has been speculated that Rajan’s resignation was expedited as he became exasperated by a small number of party members whom constantly criticised his cautious approach to inflationary pressures.  The dovish members of Modi’s Bharatiya Janata Party will be disappointed with the appointment of Patel believing he is effectively Rajan 2.0.

Modi and Finance Minister Arun Jaitley have effectively rebuked those party members agitating for faster and deeper rate cuts, paying little regard for the potential inflation that could be triggered by cutting rates too quickly.  This is yet another indication that Modi is strengthening his resolve to push forward with reforms, whilst admonishing party dissidents.

Rajan was astute in his assessment of the need to manage inflation through careful monetary policy, hence the introduction of an inflation-targeting regime.  This policy has recently been rubber stamped by parliament, another positive step following rumours that Rajan’s exit would see a climb-down by the government on controlling inflation pressures.

Modi and Finance Minister Arun Jaitley have effectively rebuked those party members agitating for faster and deeper rate cuts, paying little regard for the potential inflation that could be triggered by cutting rates too quickly.

Patel, who became Deputy Governor in early 2013, was tasked with heading up the inflation-targeting working party, resulting in the flexible inflation targeting monetary policy framework.  The implementation of a 4% inflation target (+/-2%) for an emerging economy is a significant milestone.  In the short-term, some investors will be disappointed by the appointment as they might have hoped for a rate cut in the coming weeks.  However, we believe that investors should be concentrating on the medium to long-term outlook for India, which is more favourable following Patel’s appointment.

The new Governor will also have the task of cleaning up the Public Sector Undertaking banks, a sector we currently avoid in the India Equity Opportunities Fund.  While the government has been keen to support this segment of the banking sector through capital injections, Patel will likely seek to challenge the banks themselves to create their own solutions, a more hard-line stance than that taken by his predecessor.

In summary, it can be argued that Patel is very much Rajan 2.0, while some believe that Patel is even more hawkish than the departing Governor.  While this might be the case, once in the top position, Patel may find that he has to slightly curb his hawkish views to be more accommodating to the broader party wishes.  We therefore anticipate further rate cuts of 25bps, and possibly more before the end of FY17 but this is dependent on the good monsoon leading to a fall in food prices in the months ahead. 

Prime Minister Modi has had a successful few weeks with the Goods and Services Tax constitutional amendment being passed, the rubber-stamping of the inflation targeting regime and now the appointment of a new governor who should continue the excellent work of the departing Rajan.  India will continue to be a favoured investment destination over the long-term with GDP growth above 7.5% forecast through 2020 and the benefit of an aspirational youth, with >65% of the population under 35 years old driving domestic consumption for a generation and beyond.