His exit may lead to less hawkish bias at RBI and could mean a rate cut returning to the agenda

By BLOOMBERG

MUMBAI • Urjit Patel (picture)’s shock exit as governor of the Reserve Bank of India (RBI) roiled financial markets already nervous about early election results showing Prime Minister (PM) Narendra Modi’s ruling party losing support in key states.

The rupee dropped as much as 1.6% against the dollar in early trading yesterday, reacting to Patel’s decision to quit nine months before the end of his three-year term for “personal reasons”.

The currency later pared losses, and bonds and stocks erased declines as investors braced for a tight finish in the key Madhya Pradesh state. The rupee was down 0.7% as of 2.30pm in Mumbai yesterday, while yields on 10-year sovereign bonds fell eight basis points. The S&P BSE Sensex gauge of stocks gained 0.5%.

Patel’s RBI had been at loggerheads with the government for weeks, fending off pressure to ease lending restrictions and transfer more of its excess capital to the state. A board meeting had been scheduled for Friday, at which government representatives were expected to seek changes to the central bank’s governance structure. It’s unclear if the board meeting will still proceed this week.

Patel’s departure adds another layer of risk to an economy facing multiple threats, both foreign and domestic. The rupee is among the worst performers in Asia this year, the economy is weakening and the banking sector is in crisis.

“Investors’ concerns over the independence of the RBI are now higher than ever, but it is unlikely that the government will name another figure with a reputation for independence to lead the bank,” said Sasha Riser-Kositsky, a senior analyst at Eurasia Group.

“The government faces a tough general election fight next year amid lacklustre job creation and slower economic growth than it had promised.”

The tension between the RBI and the government was laid bare in an October speech by deputy governor Viral Acharya, who defended the central bank’s independence and warned of a market backlash should it be undermined.

Patel, who succeeded Raghuram Rajan in September 2016, has tried to burnish the RBI’s credentials as an inflation- fighting central bank.

After hiking interest rates twice this year, the RBI left rates unchanged last week, while giving itself room to move again by sticking to its “calibrated tightening” stance.

The exit of Patel may lead to a less hawkish bias at the RBI and could mean a rate cut returning to the agenda as soon as February, said Abhishek Gupta at Bloomberg Economics in Mumbai.

Investors will hope for a credible successor who’ll bring continuity, said economists at Citigroup Inc. They noted that nine of the bank’s governors since 1970 have had previous experience in institutions such as the International Monetary Fund, and pointed out that it took more than two months to replace Rajan.

Investor confidence in Indian assets had only recently bounced back, helped by a slide in oil prices and a dovish tone from the US Federal Reserve (Fed). November saw the best rupee gains in nearly seven years, while local stocks saw their best month since July.

Taimur Baig, chief economist at DBS Group Holdings Ltd in Singapore, said there’s no reason to be overly negative about Patel’s successor, since the government had previously made credible appointments at the bank.

“One need not be very pessimistic about the successor, because this government has shown that it can pick people who can be a good steward of the economy,” he said in an interview with BloombergQuint.

Oxford-trained Patel, who shunned the public spotlight as governor, was initially seen as a Modi ally after he appeared to back the PM’s controversial ban on high-value currency notes in November 2016, which hurt the economy and led to thousands of job losses. Since then, he has battled to get India’s struggling banking system in order and punish errant borrowers who have stopped servicing their debt even though they have the ability to pay.

Patel tightened rules on weak state-run banks earlier this year, restricting their ability to lend.

The government wants the RBI to relax the rules, so banks can lend more easily and keep the economic engines firing ahead of a general election next year.

The Indian central bank is not alone in facing political heat, with challenges to the independence of monetary policymakers a theme of 2018. The Fed has weathered criticism from US President Donald Trump, while counterparts in Turkey and the UK have also been pressured by policymakers.

“Short-term political gain, but with potentially incalculable long-term damage to the commitment to credible economic policy”, Vivek Dehejia, an associate professor of economics at Carleton University in Ottawa, said on Twitter on Monday. It “is a very tragic day for India and for sound economics”.