NEW DELHI (BLOOMBERG) – India’s central bank governor unexpectedly resigned amid public clashes with the government, roiling markets and igniting fresh speculation over how independent the institution is from politics.

In a short statement posted on the Reserve Bank of India’s (RBI) website, Dr Urjit Patel said he is stepping down “on account of personal reasons”, the latest chapter in a global debate on whether politicians are increasingly undermining the independence of central banks.

Indian rupee one-month forwards slumped 1.6 per cent, the most since August, while stocks and bonds are expected to extend declines on Tuesday (Dec 11) as investors assess the fallout of the resignation.

The move comes ahead of a scheduled board meeting on Friday (Dec 7), in which government representatives are expected to push the RBI to do more to ease a cash crunch and transfer more of its excess capital to the state.

Prime Minister Narendra Modi faces an election early next year and his administration has put pressure on the central bank to spur lending.

The government was not informed of the decision, said an official, who asked not to be identified citing rules, while Finance Minister Arun Jaitley separately thanked Dr Patel via Twitter for his services.

Dr Patel, who succeeded Dr Raghuram Rajan in September 2016 for a three-year term, has been at loggerheads with the finance ministry on matters including the banking crisis and interest rates.

The differences came out in the open when deputy governor Viral Acharya, in a hard-hitting speech in October, defended the central bank’s independence and sought more freedom in supervising state-run lenders.

“This was completely unexpected coming just ahead of a scheduled board meeting. We will see a kneejerk selloff in all asset classes Tuesday,” according to Ms Lakshmi Iyer, head of fixed income at Kotak Mahindra Asset Management Co. “And if the declines comes with a bad poll outcome for the BJP, we may see a big drop.”

Oxford-trained Patel, who has tried to stay away from the spotlight, was initially seen playing along with Prime Minister Narendra Modi after he backed a ban on high-value currency notes in November 2016. Since then, he has waged a war 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.

BITTER PILL

Earlier this year, the RBI introduced new rules forcing lenders to declare a delinquent borrower even if payments were overdue by a day. That was aimed at easing mounting bad loans, particularly from the power sector.

Dr Patel also moved in to ring-fence weak state-run banks. Currently, a total of 12 banks – 11 in the public sector and one in the private sector- are under the so-called prompt corrective action framework that places curbs on lending, expanding branch network and dividend distribution.

The government wanted 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. But the RBI wants these banks to be slowly nursed back to health. According to the central bank, it needs to be independent so that loan losses of banks are not swept under the rug by compromising supervisory and regulatory standards.

“Maybe he thought it’s better to leave with dignity than to have to go under duress,” said Dr Pronab Sen, former chief statistician of India. “It’s one thing for the RBI and ministry of finance to discuss an issue and quite another for the finance minister to discuss and give very specific policy directives.”

NOT ALONE

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

The risk is that political pressure could backfire. A study in the 1990s by economists Alberto Alesina and Lawrence Summers concluded that independent central banks were better at controlling inflation without damaging output or employment. Markets may also push up long-term borrowing costs if they fear central banks are taking their eye off inflation.

The RBI’s independence came under threat last month, when the government sought greater oversight on the central bank’s functioning and a review of its economic capital framework. Dr Patel has also disagreed with the government’s demand for more share of profits from the RBI’s operations. A transfer of more dividend helps the government meet its budget gap aim.

Dr Patel also tried to burnish the RBI’s credentials as an inflation-fighting central bank. The six-member Monetary Policy Committee delivered two interest rate increases this year amid rising crude oil prices and weakening rupee. It paused in October and December as financial conditions tightened and signs emerged of demand in the economy is slowing.

“The greatest risk is macroeconomic,” Mr Shreyans Bhaskar, a research analyst with the Economist Intelligence Unit in India. “Investor sentiment is likely to be negatively affected, particularly if the government appointed a bureaucrat as the next governor.”

Source: Read Full Article