RBI Governor Urjit Patel’s short-term goals: Meeting inflation target, NPA clean-up

Continuing his predecessor’s efforts at cleaning up PSU banks’ books and controlling the sudden spurt in inflation, are the major issues that will keep the new Governor busy in the near future.

Written by Sandeep Singh | New Delhi | Updated: August 23, 2016 9:10:38 am
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With soaring inflation and the rupee hitting its all-time low, Raghuram Rajan had taken over as the Governor of the Reserve Bank of India at a difficult time for the Indian economy. Urjit Patel, too, will have to face his own set of challenges as he begins his journey at the helm of the central bank on September 4.

Greater stability on the currency front and relatively lower inflation levels notwithstanding, economists feel that a sudden spurt in inflation, which hit a 23-month high of 6.07 per cent in July led by a jump in food inflation, is something that may keep the new Governor busy for some time.

While Rajan pushed banks to recognise bad loans and thereby clean up the system, experts feel that as the banking sector faces risk of a further rise in the non-performing loans, particularly of the public sector banks, Patel will now have to negotiate with the same.

“While the initial challenge for the new Governor will be to deal with the upcoming FCNR(B) redemption which starts in November, he will also have to deal with a possible rate hike by US Federal Reserve, expected to begin in December,” said Abheek Barua, chief economist at HDFC Bank. He added that it remains to be seen as to how the RBI brings down the inflation to 4 per cent, which is its long-term objective, and manages the issue of non-performing loans at public sector banks.

The markets were expecting a rate cut in the next monetary policy review meeting in October. However, jump in inflation levels and Patel’s appointment is forcing people to temper their expectations.

A statement issued by Standard Chartered said: “A negative near-term impact on the rates market is likely, as Patel is considered equally hawkish as his predecessor Rajan, if not more so. Thus, expectations of significant policy easing are likely to fade.”

It is important to note that Patel had in his report in January 2014 proposed to adopt the retail inflation i.e. CPI (instead of WPI) as the anchor for monetary policy as RBI redefined itself as an inflation-targeting central bank.

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There are others who expect that inflation management may remain a key concern for the incoming Governor. In a statement issued after Patel’s appointment, Marie Diron, senior VP, sovereign risk group at Moody’s Investors Service said that there are upside risks to inflation going forward. “First, the implementation of the 7th Pay Commission recommendations could raise price and wage pressures in sectors beyond the public sector. Second, with around half the consumer price basket accounted for by food items, headline inflation will be largely accounted for by developments in food prices which are less predictable than other price developments, posing a challenge to the RBI,” said Diron.

Apart from inflation, which Patel will keenly monitor before biting the rate cut bullet, he is also expected to carry forward the book cleaning process of the public sector banks. Meanwhile, the credit growth in the economy hit a low of 7.3 per cent in June 2016.

Under Rajan, the RBI took steps towards banking sector reforms and as part of its asset quality review (AQR), banks were forced to recognise a significant proportion of the stress on their books over the past few quarters. Though it resulted in deep losses for several banks, many feel that the work remains unfinished and is yet to be completed.

“Investors will look to the new RBI Governor to continue the banking sector clean-up with the same urgency (Rajan was targeting fully cleaned-up and provisioned balance sheets by March 2017),” said Standard Chartered.

Even Moody’s, in its annual credit analysis, released on Monday pointed that India’s susceptibility to event risk is driven by banking sector risk and thus the clean-up process should continue as it will be credit positive.

Stating that the non-performing loans will rise further, particularly for public sector banks, Moody’s added: “The authorities’ focus on bad asset recognition and provisioning in the banking system as well as the recent passage of a new bankruptcy bill would be credit positive from a sovereign perspective, if it led to improved bank capitalisation levels, renewed loan growth and robust risk processes.”

DK Joshi, chief economist at Crisil said that the clean-up job at banks is only half done and remains one of the major tasks to be completed by the new Governor. He, however, said that the governor will have to closely watch out external factors. “While Brexit will play out going forward, the governor will also have to see through the impact of the continuing quantitative easing by several countries,” said Joshi.

Another major task at hand is the redemption of FCNR deposits, which is likely to result in an outflow of around $20 billion. Under FCNR deposits, NRIs or Indian nationals are allowed to hold fixed deposits in banks in foreign currency thereby safeguarding them against any adverse currency volatility.

The redemption issue pertains to the money raised by Indian banks through FCNR deposits in 2013. Soon after Rajan took over in September 2013 (when rupee was under pressure and had hit a low of 68.8 against the dollar), one of the first announcements he made was a special concessional dollar swap window to attract FCNR deposits and foreign currency borrowings.

While banks raised a total of $34 billion, $25 billion was raised via FCNR deposits and it is due for redemption in November this year. While Rajan has earlier said that RBI will provide dollar and rupee liquidity if needed to prevent any disruption in the market, market experts feel that the event may lead to volatility in the currency, equity and debt markets.

It will also be important to see how Patel manages RBI’s communication with Centre. Maintaining a balance between government’s expectations and RBI’s policy stance will be crucial especially since he is a direct appointment of the NDA government after the current Governor, Rajan, did not seek an extension even though he was willing to continue for some more time.

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