As Raghuram Rajan
delivered his final monetary policy earlier this week, the stage is set for the next RBI
Governor. Media reports suggest that the shortlist includes luminaries such as the current RBI
Deputy Governor, Urijit Patel, former Deputy Governor, Subir Gokarn, as well as Chief Economic Advisor, Arvind Subramanian, Secretary Economic Affairs, Shaktikanta Das, and Niti Aayog Vice-Chairman, Arvind Panagariya.
Whoever is the final choice, markets would look forward to only one thing – rate cuts. Unfortunately, even the most dovish of RBI
Governors would find it hard to justify deep rate cuts going into the next few years. Moreover, with the monetary policy committee taking over, the decision over rate cuts will now be a collective one between the RBI
and the Government; although in case of a tie the final decision will still rest with the RBI
Governor. So, what is the new RBI
Governor inheriting? Let’s take a look:
: The RBI
now has a specific range for inflation, namely a band of 2% to 6% over the long term. However, June inflation
printed at 5.77% - up for the third consecutive month and already near the top end of the band. The new RBI
Governor will have to contend with bringing this down to the stated target of 5% by March 2017. While a good monsoon should cool off food prices, the implementation of the Seventh Pay Commission could raise demand and cause inflation
to go up. As the monetary policy statement noted, “Going forward, the strong improvement in sowing on the back of the monsoon’s steady progress, along with supply management measures, augers well for the food inflation
outlook.” However, there are two key risks over the longer term: first, if oil prices start to rise globally, fuel inflation
and its second-order impact on food prices could come back with a vengeance and second, if the Government stokes inflation
by raising expenditure ahead of state elections due in 2017 and the general election (in 2019). The new RBI
Governor will have to keep all these moving parts in balance.
2. Interest rates
: Starting from January 2015, the RBI
cut the repo rate by 150bps till April 2016, with the bulk of these cuts (125bps) coming in 2015. For many in the industry, these weren’t enough. They wanted more and believed that high interest rates were to blame for the sluggishness in industrial demand. Thus, the new Governor inherits expectations of more rate cuts to keep industry happy, since it is now well-accepted that Rajan’s hawkish stance on inflation
didn’t earn him enough friends to ensure his term was renewed. Currently, India’s repo rate stands at a five-year low of 6.50%. The key question is how much can these rates fall by? The lowest repo rate has been 4.25%, but that was in response to the global financial crisis in 2009/2010. Even if you assume the repo rate matches the inflation
rate – at 5% -- that is a window of 150bps over the next 1-2 years. However, this is an optimistic scenario and will not happen quickly. Even the most dovish of RBI
Governors would be hard-pressed to throw caution to the wind, to satisfy the demands of industry.
: The Indian rupee has done well, holding its own in 2016. After nearly touching Rs69/USD at the panicked start of this year, the INR has remained within a tight range of Rs66-68/USD. India’s current account deficit is firmly under control, and its foreign exchange reserves also remain strong. The redemption of FCNR(B), due this year, will also not strain the system, as noted by the RBI. However, over the longer term, any global crisis could strain the system as it had in 2008. The longer term impact of negative interest rates in major economies and a hike in interest rates by the US is unknown. What is known, as seen in 2013, is that global crises can put India’s external situation under stress. Should the new RBI
Governor, face one, he should speak with Governor Rajan
who had inherited a similar crisis and did an admirable job responding to it.
Thus, the incoming RBI
Governor inherits an economy pegged to grow at 8% this year, with inflation
targeted to reach 5% by March 2017, and repo rates at 6.50%. Those are merely the numbers. The job will be larger and far beyond mere management of targets.
Anupam Gupta is a Chartered Accountant and has worked in equity research since 2000, first as an analyst and now as a consultant. He contributes to the Business Standard platform, Punditry, through his blog, Beyond Markets on markets & the economic horizons.