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Dr. Urjit Patel will become the 24th Governor of the RBI this coming weekend, taking over from Dr. Raghuram Rajan who returns to academia after a three-year tenure with the Central Bank. During this time, Dr. Patel has worked rather closely with Dr. Raghuram Rajan, who has now added his voice in praise of Dr. Patel’s capacities.
Beyond that, the market may know little about the policy measures that Dr. Patel may unfold. On the one hand, he has been the architect of the metamorphic transformation in the monetary policy framework that has made India officially an inflation-targeting economy. The report that brought this historic change is after all called the Urjit Patel Committee report. That signals stability, continuation and a building on the groundwork of the last few years under the leadership of Dr. Rajan. But on the other hand, the vacancy that Dr. Patel fills was created following a controversy that was stirred up over these very policies, notably over the demand for lower interest rates at a time inflation remains a concern. In a strange way, Dr. Patel is the architect of a lot of the change that makes these years historic for the RBI but it is some these very changes that led to conditions under which Dr. Rajan was made not comfortable enough to continue as Governor.
At the very least, the RBI will be in for some kind of culture change because unlike Dr. Rajan, the incoming Governor is reported to be a man of few words and it will not be surprising if the market and the media once again get a taste of the classic (old-world?) adage that a “Central Bank Governor is to be seen, not heard.”
Some thinking of Dr. Patel can be drawn from his published papers or research articles. The thinking is probably only mildly indicative and may or may not hold as he takes charge at the RBI. But it does shine some light on ideas and perspectives that will be somewhere on the horizon during his tenure. The reading does open up some exciting new areas that go against conventional wisdom and have been followed in India as the norm, what Dr. Patel called “a long standing feature of the Indian economic landscape”, like the instrument of the Statutory Liquidity Ratio, the SLR.
In a co-authored paper titled “Fiscal Rules in India: Are They Effective?” (with Willem H. Buiter) published six years ago by the National Bureau of Economic Research, Massachusetts, Dr. Patel spoke on political trends and pressures seen in India. He wrote: “It is often said that the main reason for India’s historic price stability relative to its peer group of developing countries has been the polity’s intolerance of high inflation (hence, a conservative monetary stance for the most part).”
With regard to fiscal policy, the paper said, “it would seem that the preference is for high expenditure and low taxation. Political opportunism in India as elsewhere calls for the postponement of expenditure cuts or tax increases and the prompt spending of revenue windfalls – there is always the chance that the political cost of painful fiscal retrenchment will be borne by the opposition, when its turn in office comes around.”
Dr. Patel puts the spotlight on an age old policy instrument, the SLR, which earmarks a fraction of liabilities of banks for investment in central and state government securities. He went on to argue that policy-induced frictions are primarily on account of the SLR, which from early days has had a prime place in the RBI toolkit and currently stands at 21 per cent.
In a more recent co-writing (published January 2016) as part of the “RBI Working Paper” series, titled “Challenges of Effective Monetary Policy in Emerging Economies” (with Amartya Lahiri), Dr. Patel discussed the strains between the monetary authority (the RBI) and the fiscal authority (the government). He wrote: “The question is who blinks between a monetary authority that is adhering to price stability…and the fiscal authority, who…is not keen to correct an unsustainable primary fiscal deficit through spending cuts or tax increases and prefers to have the monetary authority directly monetise (accommodate) the public debt.”
The inevitable outcome is that the central bank will monetise the debts and deficits. This is called fiscal domination over monetary policy, a theme that should be playing high up as the incoming Governor considers his policy moves and the road ahead.
Here, Dr. Patel puts the spotlight on an age old policy instrument, the SLR, which earmarks a fraction of liabilities of banks for investment in central and state government securities. He went on to argue that policy-induced frictions are primarily on account of the SLR, which from early days has had a prime place in the RBI toolkit and currently stands at 21 per cent. Though the required ratio is 21 per cent, many banks have higher than this prescribed minimum, locking in their funds at lower than market rates.
Dr. Patel argues in the paper that SLR actually blocks the transmission of the monetary policy. It is instructive as well as interesting to quote him in this regard: “...when the SLR constraint is binding, the monetary transmission mechanism becomes so scrambled that it can end up inverting the effects of changes in the policy rate on the key interest rate spreads – raising the policy rate could reduce lending spreads while lowering rates could raise the lending spread.”
Dr. Patel then argues that in such circumstances, changing the SLR level itself is more likely to yield conventional effects of monetary policy, i.e., a fall in SLR would act like a monetary expansion while an increase in SLR would be a monetary contraction.
If Dr. Patel tweaks the SLR, he will free up funds for lending but at the same time, the banks so liberated should be held to account for their performance and a better management of their portfolios. Of course, he will have to play his options amid a host of challenges. Inflation management, NPA management, currency management and concerns on financial inclusion are among the top ones that will stare him in the early days.
Dr. R K Pattnaik is Professor, SPJIMR. Jagdish Rattanani is Editor, SPJIMR. Views are personal