RBI Governor Urjit Patel Resigns. What Next?

What to expect from markets tomorrow, on Patel's successor and how the RBI-Modi government face-off will be resolved.

New Delhi: Reserve Bank of India (RBI) governor Urjit Patel’s resignation has thrown India’s financial policymaking establishment in a tizzy, coming as it does after what most saw as a temporary truce between the central bank and the Modi government.

Patel’s decision to quit for “personal reasons” with immediate effect raises three pressing concerns.

First, how badly will this affect India’s markets tomorrow? Secondly, who will take over the job of central bank governor in the interim?

And lastly, what will happen in the next RBI board meeting and what will this mean for the issues that served as a bone of contention between the central bank and the Modi government?

On what to expect in tomorrow’s market movement

India’s stock and currency markets are expected to be severely and adversely affected. While Patel’s resignation was announced after most markets closed, the dollar-rupee one-month forward contract spiked 1.1% to 72.38 against the dollar and the Singapore-traded Nifty futures lost 1.3% to 10,390 at 5:30 pm.

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

Other money market experts expect that tomorrow will see a shake-up.

Also read: Reserve Bank of India Governor Urjit Patel Resigns

“I think it will be very difficult now to find somebody. We have to recognise now that the government’s style of functioning is not what the RBI needs or wants,” Jamal Mecklai Of Mecklai Financial Services told Bloomberg.

“It would be pretty rocky. The rupee has already fallen 72.50 in the non-deliverable market. My sense is that there is no real operational fundamental change. This is really a reflection on the politics. Usually, political instability is overplayed. But it looks pretty grim right now, no way of knowing what’s going to happen.”

Paresh Nayar of Mumbai-based FirstRand said that markets would react “very negatively”.

“Markets are going to react very negatively to this news. It’s not a good outcome at all,” said Nayar, who is the head of currency and money markets at FirstRand.

On choosing Patel’s interim and permanent replacement

According to people with knowledge of the matter, Patel’s resignation came as a shock for the Modi government, which didn’t have time to put out an official Press Information Bureau release and instead released reactions on Twitter.

Therefore, it’s not clear if the Centre has a clear replacement for Patel in mind at the moment.

Most former central bank officials The Wire spoke to indicated that in this case, the Modi government would have to appoint an official to take over in the interim before it appoints a new governor. According to the RBI Act, 1934, if the “governor or a deputy governor by infirmity or otherwise is rendered incapable of executing his duties or is absent on leave or otherwise in circumstances not involving the vacation of his appointment, the Central government may, after consideration of the recommendations made by the Central Board in this behalf, appoint another person to officiate for him…”

Also read: Explained: The Widening Rift Between the RBI and the Modi Government

The only thing the law says about this interim appointment is that it could include an officer or employee of the RBI.

It’s possible that the interim governor will come from the central bank’s four deputy governors (N.S. Vishwanathan, Viral Acharya, B.P. Kanungo and M.K. Jain) or any of its 12 executive directors.

“The Centre always has a plan B in place,” said Pronob Sen, former chief statistician, in remarks made to Bloomberg.

“There is a backup system. The question is, will the backup system be allowed to play its role? If someone is appointed within a week, the fear will be that this person had already been identified. And therefore the appointment will be seen as political. And that may turn out to be more damaging than the resignation itself,” Sen added.

On remaining contentious issues

Patel’s resignation comes four days before the central next board meeting (December 14). As The Wire reported two weeks ago, this meeting was also expected to play host to a showdown between the RBI’s management and the board’s government nominees.

The government’s directors were expected to push for reduced restrictions on lending and structural changes that would give the board more say in the central bank’s functioning.

It’s unclear whether the board meeting will take place now on December 14, although it is still a possibility if the government quickly appoints an interim replacement over the next two days.

The central bank and the Modi government disagree vehemently over five major issues, some of which were resolved at the last board meeting and some of which remain an elephant in the room. These include:

1) Transfer of RBI’s ‘excess reserves’ to the Centre.

At the last meeting, the central bank’s board decided to constitute an expert committee to examine the issue, so this has been put on the back-burner for now.

2) Removing lending restrictions on weak state-owned banks

This debate was over the controversial prompt corrective action (PCA) norms, a set of restrictive rules that are applied to unhealthy or weak banks. The Modi government wanted these norms eased to boost lending and growth, but the RBI felt that it wouldn’t be prudent to do so.

At the last board meeting, this was kicked down the road, with both parties agreeing that the matter would be examined by the a RBI sub-committee, the board for financial supervision (BFS).

Also read: Can RBI’s Independence From Government Interference Be Politically Justifiable?

3) Capital norms for banks

On this, the RBI gave in slightly at the last board meeting, when it agreed to relax in part an international capital norm for banks.

4) Helping SMBs and NBFCs

This has been a mixed bag, with the RBI’s board advising that the central bank consider a “scheme for restructuring of stressed standard assets of MSME borrowers with aggregate credit facilities of up to Rs 250 million”.

However, there’s been no further movement on this. And the RBI also hasn’t given to the Centre’s other demand, that it ease liquidity conditions for the non-banking finance sector (NBFC). The NBFC industry has reportedly faced liquidity issues since the near-collapse of IL&FS.

5) Governance shake-up

The last point is over-arching in nature. The government nominees on the RBI’s board want to transform the board from an advisory forum to a body that plays a bigger part in the central bank’s policymaking process.

In the run-up to the last board meeting, media reports noted that the Modi government wanted the central bank to set up sub-committees, which could include government nominees that would focus on different aspects of the RBI’s functioning.

Out of these five issues, at least four of them, barring capital norms for banks, are still up for debate and discussion. With Urjit Patel’s resignation, it’s unclear how much the Modi government will continue to push and what Patel’s successor plans on doing to push back.