When Raghuram Raj an became the RBI Governor in Sep 2013, the worry was that the tapering of monetary easing in the US would lead to capital flight from India, and the rupee would fall sharply. The central bank managed to halt the slide by intervention and by taking steps to augment reserves using other means. One wonders whether Urjit Patel's first problem could be exactly the opposite: strong capital inflows appreciating the rupee further in both nominal and real terms.
Advanced industrial economies are in the midst of low to negative interest rates and growth. Equities are perhaps fully priced and sovereign bonds are offering return-free risk: when interest rates go up to normal levels, investors will face a huge loss. Large institutional investors such as pension funds and life insurance companies are already worried. In sharp contrast, some emerging market economies (EMEs) are experiencing both high interest rates and growth, and should look attractive to foreign investors in terms of the risk–return trade-off.
On the fiscal front, the new Goods and Services Tax (GST) rules prevent the govts from tinkering with taxes. But their social responsibilities and promises to the electorate won't lessen. They may take recourse more and more to off-balance-sheet financing, which governor Patel may have to speak against. More immediately, Patel has to steer the forex and debt markets through the months of Oct and Nov when the FCNR deposits flow out. He will probably keep adequate liquidity in that phase. But come Dec and he will have to decide whether he can keep liquidity as easy, while moving the inflation target to 4 per cent. And finally and most importantly, he will have to set the rules for the new Monetary Policy Committee. Here he treads new ground and will have the responsibility to set good conventions and precedents. Of course, he has the backdrop of sound macros, stable politics and a substantial forex kitty. Unli)ce Rajan, he doesn't take over in a crisis.
The inflation challenge looms large. The CPI-based inflation has already crossed 6 per cent, the upper limit permissible. Of course, henceforth the rate will be decided by the Monetary Policy Committee, and not by the Governor alone. It is also true that since a big component of inflation is due to food items, it is beyond the immediate influence of interest rates. Nevertheless, the central bank can't be seen as cutting rates while the inflation rate is climbing. Also, with high consumer inflation, the depositors earn a negative return, if rates are cut too aggressively. This causes depositors to flee the financial sector, away from bank deposits to gold and real estate. Patel already has the reputation of being an "inflation warrior", thanks partly to the committee report that he chaired. Hence a sharp focus on inflation should be second nature to him.
Advanced industrial economies are in the midst of low to negative interest rates and growth. Equities are perhaps fully priced and sovereign bonds are offering return-free risk: when interest rates go up to normal levels, investors will face a huge loss. Large institutional investors such as pension funds and life insurance companies are already worried. In sharp contrast, some emerging market economies (EMEs) are experiencing both high interest rates and growth, and should look attractive to foreign investors in terms of the risk–return trade-off.
On the fiscal front, the new Goods and Services Tax (GST) rules prevent the govts from tinkering with taxes. But their social responsibilities and promises to the electorate won't lessen. They may take recourse more and more to off-balance-sheet financing, which governor Patel may have to speak against. More immediately, Patel has to steer the forex and debt markets through the months of Oct and Nov when the FCNR deposits flow out. He will probably keep adequate liquidity in that phase. But come Dec and he will have to decide whether he can keep liquidity as easy, while moving the inflation target to 4 per cent. And finally and most importantly, he will have to set the rules for the new Monetary Policy Committee. Here he treads new ground and will have the responsibility to set good conventions and precedents. Of course, he has the backdrop of sound macros, stable politics and a substantial forex kitty. Unli)ce Rajan, he doesn't take over in a crisis.
The inflation challenge looms large. The CPI-based inflation has already crossed 6 per cent, the upper limit permissible. Of course, henceforth the rate will be decided by the Monetary Policy Committee, and not by the Governor alone. It is also true that since a big component of inflation is due to food items, it is beyond the immediate influence of interest rates. Nevertheless, the central bank can't be seen as cutting rates while the inflation rate is climbing. Also, with high consumer inflation, the depositors earn a negative return, if rates are cut too aggressively. This causes depositors to flee the financial sector, away from bank deposits to gold and real estate. Patel already has the reputation of being an "inflation warrior", thanks partly to the committee report that he chaired. Hence a sharp focus on inflation should be second nature to him.
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