Fitch Ratings Wednesday said the resignation of Urjit Patel as Reserve Bank Governor highlights the risks to RBI's policy priorities and increased government influence on the central bank could undermine the efforts to address bad loan problems.
Patel resigned abruptly from the post of the Governor on December 10, nine months before his term was scheduled to come to an end in September 2019.
The Government Tuesday appointed former Economic Affairs Secretary Shaktikanta Das as the new Governor.
"The resignation of the RBI governor ... follows a period of government pressure on the central bank to spur economic growth, and highlights risks to the RBI's policy priorities," Fitch Ratings said in a statement.
The RBI's efforts to address bad loan problems have the potential to improve banking-sector health over the long term and its commitment to inflation targeting has supported a more stable macroeconomic environment in recent years.
"Increased government influence on the central bank could undermine this progress," Fitch said.
It said that a roll-back of measures that address long-standing bad-loan problems and restrict the growth of weakly capitalised banks could have a "negative impact" on the credit profiles of affected banks and may increase risks in the financial system.
The rating agency said the full implications of Patel's resignation will only become clearer once there is some indication of the RBI's policy approach under his replacement, Shaktikanta Das.
"The central bank's stance may still remain unchanged," Fitch said.
However, with general elections due by May 2019, there will be "political incentive" for the government to push for more supportive RBI policies, it added.
Fitch said Patel's resignation came after months of escalating government pressure on the RBI to ease some of the strains created by its clean-up of the banking sector.
Increased bad loan recognition has led to large credit costs - particularly for state banks - and weaker capitalisation in recent years. Capital constraints have, in turn, held back lending, while 11 state banks have fallen under the RBI's "prompt corrective action" (PCA) framework, which allows the central bank to directly restrict their lending.
Problems in the non-bank financial sector following the recent default of Infrastructure Leasing & Financial Services (IL&FS) have further reduced credit availability, Fitch said.
"The government has unsuccessfully pushed the RBI to relax the PCA thresholds to allow some troubled banks to step up lending. Calls to dilute provisions in a new regulatory NPL framework that has accelerated bad loan recognition this year and to provide emergency liquidity to non-bank financial institutions (NBFIs) have also been dismissed," Fitch said.
The introduction of a 0.625 per cent counter-cyclical buffer (CCB) that was set to kick in from April 2019 has been delayed, but the RBI has so far resisted pressure to push back the implementation of other Basel III minimum capital requirements, it added.
It said most state banks are in a poor position to ramp up lending, with their common equity Tier-1 ratios well below the 7.375 per cent that will apply from April 2019 under Basel III implementation. Some banks are also likely to continue reporting losses, further adding to capitalisation challenges.
"In terms of monetary policy, the establishment of a Monetary Policy Committee (MPC) in October 2016 and recent introduction of inflation targeting has underpinned our view that the RBI's macroeconomic policy framework is credible and effective. However, that assessment could change if government influence pushes the RBI away from its mandate," Fitch said.
Fitch had last month affirmed a 'BBB-' sovereign rating on India, with a stable outlook. 'BBB' rating implies lowest investment grade. Last week, it revised downwards India growth forecast to 7.2 per cent from 7.8 per cent for current fiscal citing higher financing cost and reduced credit availability.
India's economy remains one the fastest-growing in the world, but GDP growth slowed to 7.1 per cent in October-December quarter, from 8.2 per cent in the previous quarter.
"Patel cited personal reasons for leaving the RBI, rather than government interference. Moreover, there was no obvious break in policy continuity after the last governor, Raghuram Rajan, decided not to seek a second term in 2016, which also sparked market concerns," Fitch said.