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Ila Patnaik highlights 5 challenges that will make Urjit Patel’s job harder

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Updated: September 9, 2016 12:56:40 PM

Ila Patnaik, professor, National Institute of Public Finance and Policy, feels Urjit Patel's biggest challenge now lies in leading the reforms through which the RBI can actually influence inflation.

Until now the RBI could talk about price stability and it could respond to the inflation rate by changing the policy rate, but it was not held responsible for the outcome.Until now the RBI could talk about price stability and it could respond to the inflation rate by changing the policy rate, but it was not held responsible for the outcome.

Urjit Patel has assumed charge of Reserve Bank of India at a time when the Indian economy is in a much better position than what his predecessor Raghuram Rajan inherited three years ago. Raghuram Rajan exuded confidence that his successor Urjit Patel will carry forward the work they began on taming inflation. “I am confident that Urjit Patel, who has worked closely with me on monetary policy for the last three years, will ably guide the Monetary Policy Committee going forward in achieving our inflation objectives,” Rajan said. Ila Patnaik, professor, National Institute of Public Finance and Policy, feels Urjit Patel’s biggest challenge now lies in leading the reforms through which the RBI can actually influence inflation. Here are 5 challenges which Patnaik thinks will make the new RBI Governor’s job harder:

1) Until now the RBI could talk about price stability and it could respond to the inflation rate by changing the policy rate, but it was not held responsible for the outcome. A rise in CPI inflation could be explained by blaming fiscal expansion, demand for protein, bad measures of inflation, inadequate transmission of monetary policy and so on. What has changed now is that the RBI can no longer merely “explain” high inflation. If CPI inflation is higher than the target, it has to not only provide reasons for its failure to meet the target, but also propose remedial actions. While today it is a challenge for the RBI to even influence bank lending rates, let alone the CPI, the inflation targeting mandate requires the RBI to ensure that it is able to do so. “The responsibility of ensuring that changes in the policy rate get transmitted to the financial sector remains with the governor,” she says. It is he who will lead the RBI in managing liquidity, undertaking repo transactions, buying and selling government bonds and foreign exchange and ensuring competition in the banking sector so that the MPC’s decisions get transmitted to markets.

2) Transmission of monetary policy: Patnaik writes, transmission of monetary policy is no simple task. For example, one necessary but not sufficient condition for obtaining financial markets that transmit changes made to the policy rate throughout the financial system is a deep and liquid bond market. The bond market in India is seriously limited by the lack of an independent public debt management office and restricted access to bond markets. This is an agenda that needs both legislative change and institution building. It needs cooperation between the RBI and government to make it work. Creating an independent public debt manager and the accompanying bond markets in which the debt office would sell government debt will be a crucial element in improving transmission of monetary policy.

3) Communication: A key element of Governor Patel’s strategy will have to be communication, she says. Communication to show his commitment to the inflation targeting framework will give it credibility. Rajan’s legacy of regularly repeating the RBI’s commitment to inflation targeting was in sharp contrast to the flip-flops in the speeches of some of his predecessors. Patel has to continue Rajan’s legacy. While markets do assume that he supports the inflation targeting framework, speeches and statements emphasising his commitment to the framework will strengthen and consolidate it. This is particularly important in the present context when questions have been raised about elements of the framework.

4) Financial market reforms: Patel will have to take a path of the financial market reforms to improve the transmission of monetary policy. Some ground work has been done and recommendations are available in the form of the Percy Mistry, Rajan and FSLRC report. However, actual legislative and institutional reform is tricky and involves adept political manoeuvring. It involves negotiating both with the government and with RBI staff. Patel’s experience as deputy governor should come in useful in playing this complex role. The task of negotiating the path of reform will be an enormous challenge.

5) The stress in Indian banking: An alphabet soup of restructuring schemes like the CDR, SDR, S4A has not succeeded. The Bankruptcy Code will not yield results in the next couple of years. It is said that almost any negotiated settlement by banks runs into fear of the 3 Cs — the CAG, CVC and CBI. As a consequence, public sector bank officials are reluctant to sign off on haircuts.

She concludes by saying, “there is no easy way out. Patel, no doubt, understands the enormity of the challenges he faces. As an insider, he would know not just the problems, but also the difficulties that any simple solution poses. This, in itself, is an advantage.”

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