Turning the page: Focus on external front new RBI governor's first test

After much anticipation, the Union government on Monday appointed Revenue Secretary Sanjay Malhotra next governor of the Reserve Bank of India (RBI). The term of incumbent Governor Shaktikanta Das ends today. Mr Malhotra, an engineering graduate from the Indian Institute of Technology, Kanpur, with a master’s degree in public policy from Princeton University, is a 1990 batch officer of the elite Indian Administrative Service. Interestingly, the government for the second time in a row has chosen a career bureaucrat and not a professional economist to lead the RBI. The decision may have been motivated by the experience of Mr Das’ term, which rarely witnessed friction between the RBI and the government. However, with the Budget-making process underway, the Ministry of Finance will have to quickly find a replacement for Mr Malhotra. 

Mr Das’ term over the past six years was fairly challenging for both the Indian economy and the RBI, largely because of the pandemic. The RBI had to take emergency measures and ensure the financial system remained resilient. While the RBI took several steps during and after the pandemic, there are two areas from policy and financial stability points of view that are worth discussing here. First, the RBI is an inflation-targeting central bank. Although the responsibility of setting the policy interest rate is now with the six-member Monetary Policy Committee (MPC), the term of any governor will, in part, be judged by the record on inflation management. In this regard, it is fair to argue that the RBI underestimated the inflationary impulse over the past few years. However, once it started policy tightening, it did well to not reverse it prematurely. The MPC is willing to wait to complete the disinflation process. 

The second is external-sector management. After initial volatility during the pandemic, as large global central banks started pumping liquidity into the system besides taking the policy rates to near zero, India witnessed a significant surge in capital inflows. The RBI did well to absorb excess flows. Higher reserves helped a great deal in 2022, when large central banks, led by the United States (US) Federal Reserve, increased policy interest rates in a coordinated way to deal with inflation. Global currency markets witnessed significant volatility. Although the rupee did depreciate during this period, the impact was limited because of the active intervention of the RBI. Maintaining stability on the external front has been one of the highlights of the RBI’s efforts over the past few years. In fact, some economists have argued that the rupee is too stable. It has indeed been overvalued, which can affect the competitiveness of tradable sectors. 

In this context, Mr Malhotra’s challenge will be to ensure that currency-market interventions do not become a burden on the tradable sector while containing excessive volatility. This aspect will be closely watched from the very beginning of his tenure. Policy changes promised by US President-elect Donald Trump can have significant implications for currency markets. On the inflation front, while the projections suggest that the inflation rate will align with the target of 4 per cent in the second quarter of next financial year, the RBI and MPC will need to be careful and ensure that the decline is durable. While the RBI expects growth to recover in the coming quarters, surprises on the lower side could put pressure on the central bank to support growth. One of the important tools in the toolkit of modern central banks is communication. This improved significantly during Mr Das’ term and is something Mr Malhotra will be expected to build on. Besides, it will be interesting to see if the RBI changes its stance on cryptocurrencies.