Now that the uncertainty over the appointment of a successor to Raghuram Rajan to the top job at the Reserve Bank of India (RBI) is over, the focus shifts to the challenges facing the new governor. For Urjit Patel, there will be no immediate trial by fire, unlike for Rajan, who took over when the economy was battling double-digit inflation and a rupee in free fall. That is hardly the case now, with India’s fiscal as well as current account deficits under control and the rupee among the better-performing currencies in the last two years. True, consumer price index (CPI) inflation has been on the rise. The latest 6.07 per cent annual rate for July is not just the highest in 23 months, but also more than the six per cent upper limit target fixed under the new statutory monetary policy committee (MPC) framework. The current inflation number should, however, ease with the arrival of a bumper kharif crop from October on the back of a good southwest monsoon.
Adherence to a six per cent inflation target can, nevertheless, be challenging down the line, when it is defined in terms of an index where food items have a nearly 46 per cent weight. With the economy far from showing tangible signs of revival, there is certainly a strong case for lowering interest rates today. The pressure for that will increase if growth — more so, in investments and jobs — remains weak, even as the present government enters the second half of its tenure. If harvest failures tomorrow were to result in interest rates going up even while the underlying demand factors for generalised inflation are absent, it could create a politically (and economically) unsustainable situation of joblessness co-existing with high food prices. Inflation targeting based on overall CPI — a committee under Patel was the one that first proposed it — may have had relevance in 2013-14, when India’s commitment to macroeconomic stability was under a cloud. In the present context, though, some tweaking may be in order. The MPC — the new body headed by the RBI governor, which will be responsible for setting policy rates — can consider some “core” CPI measure that would reflect generalised inflationary pressures stripped of volatile components like food and oil prices.
Patel would also do well with continuing the policies of Rajan with regard to full recognition of stressed loans by banks, transparent licensing of new banks and pushing financial inclusion, including by making bank-to-bank account transfers easier via mobile using the new Unified Payment Interface. Equally important is working closely with the Centre to reform governance in state-owned banks. The ongoing clean-up of balance-sheets will have no meaning if not followed up by action on professionalisation and accountability of bank boards that comes with separation of management from ownership.