Crisis or no crisis, Dr Urjit Patel has tough task ahead of him

Former Governor Raghuram Rajan bid adieu in style. He presented his successor a memento bearing an image of the rupee with the words “Our Responsibility” inscribed on it.

Maintaining the value of the rupee may not be as easy a responsibility to discharge in the days to come. In fact, Governor Patel may actually face a more uphill task than Rajan in practically all departments.

Let us start with inflation control and the demand for rate cuts. Quite a few ministers and corporate honchos believe Rajan paid a price for not cutting rates and demands have already come from ministers like Nitharaman Sitharaman for rate cuts for special segments.

While Rajan had the sympathy of the markets at least  during his first year in office when inflation was in high single digits, Patel comes at a time when inflation will fall to 5 percent when the reading comes next week. His pitch is queered by the fact that he has to start the journey towards 4 percent inflation.

He therefore has really no room to cut rates and has the difficult task of breaking this news to markets. If he puts off the deadline for 4 percent CPI, he may risk losing credibility at least with global bond investors. His job of resisting rate cuts will only get tougher as the government enters its fourth year in office and will be under greater  pressure to show growth and performance.

Likewise Governor Patel’s challenges on the banking front will also be more onerous. Rajan had the tough task of telling banks to recognize bad loans. Patel will have the even tougher task of resolving them or cajoling the government to find the capital.

Patel’s third tough task is implementing the rule that banks can’t lend more loans to companies with more than Rs 26,000 crores of debt, starting FY18. These limits on bank lending will get lower in FY19 as draft rules require banks to bring down their group exposure from 40 percent of total capital to 25 percent of Tier 1 capital.

The test will come when telecom companies ask for loans for spectrum auctions or when road contractors ask for loans for the upcoming freight corridor or smart cities projects. Governor Patel may find it tough to stick to the derisking rules in the face of political and corporate pressure.

The move from bank-led lending to capital market-led lending won't be easy. Not only will he have to choke off bank lending to leveraged companies, Governor Patel will also have to convince the government and rival regulators to allow pension funds and insurance companies to buy more corporate bonds.

The EPF trustees long resisted moves to invest even 5 percent of their funds in equities. Getting public opinion to accept insurance and pension funds into investing in lower-rated corporate and infrastructure bonds will be a tall order.

Today, the system is unable to force even companies defaulting on their debentures to pay  their investors. The bankruptcy code is expected to make a difference. But it remains to be seen if national company law tribunals are set up quickly and if the judiciary co-operates by not allowing appeals endlessly from such tribunals.

Clearly governor Patel is not going to find it easy to lead India Inc from bank-led financing to market-led financing of their capex.

On the fiscal front, the new GST rules prevent both the central and the state government from tinkering with taxes. But their social responsibilities and promises to the electorate won’t lessen. They may take recourse more and more to off balance sheet financing which governor Patel may have to speak against.

More immediately, Dr Patel has to steer the forex and debt markets through the months of October and November when the FCNR deposits flow out. He will probably keep adequate liquidity in that phase.

But come December, he will have to decide whether he can keep liquidity as easy, while moving the inflation target to 4 percent.

And finally and most importantly, he will have to set the rules for the new Monetary Policy Committee. Here he treads new ground and will have the responsibility to set good conventions and precedents.

Of course, he has the backdrop of sound macros, stable politics and a substantial forex kitty. Unlike Rajan, he doesn’t take over in a crisis. But the new governor may well find that normalcy is not much easier than a crisis.