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Illustration: Shyamal Banerjee/Mint
Illustration: Shyamal Banerjee/Mint

A host of challenges for Raghuram Rajan’s successor

Continuing the incumbent's good work will require deft footwork

Raghuram Rajan’s successor at the Reserve Bank of India (RBI) will find the Indian economy in much better shape than it was when Rajan himself took charge three years ago. Inflation has slowed, the current account deficit is under control and the rupee has shown remarkable resilience in recent times. However, even in this relatively stable environment, the new governor will face a number of short- and medium-term challenges—some of which will be a first for the RBI itself.

First, the government on Monday decided to bring provisions of the amended Reserve Bank of India Act on the constitution of the monetary policy committee (MPC) in force. The new governor will have to oversee the completion of the formal migration to a new monetary policy framework which will be completed once the MPC starts working. As highlighted in these pages before, the disinflationary momentum in the economy has ended, and bringing inflation down from here on will not be easy because of its visible sticky nature.

Second, the new governor will straightaway have to deal with the redemption of foreign currency deposits that were raised in 2013 to stabilize the rupee. The central bank has estimated that about $20 billion will leave Indian shores on this account. Although the RBI has done well by entering into forward contracts to meet the demand, things can still get volatile because of unfolding risks in the global financial market.

Brexit tops the list here. As of now, it is not clear as to what extent it will affect the UK, the European Union and the world economy as a whole. Financial markets hate uncertainty and the general tendency is to move away from risk assets in such conditions. This can add to the redemption pressure and lead to significant volatility and weakness in the currency market.

Third, RBI under the new governor will have to learn to regulate new-age payments and small finance banks as they start rolling out operations. It is possible that things may not go the way the central bank or other stakeholders have envisaged. After all, it’s an experiment, and the surrendering of in-principle licences by some participants suggests that things will not be easy. The central bank may have to reconsider the rules of the game in the medium term.

Fourth, the new governor will have to take the fight against bad loans to its logical conclusion. It is important that non-performing assets are fully recognized and the issue is addressed in a fair and transparent manner. There has been resistance in the system to the way RBI has pushed banks to come clean on asset quality. The new governor will have to complete this process, work with the government to further empower banks in dealing with bad assets, and bring in changes so that a similar situation can be avoided in the future.

Fifth, and perhaps the biggest challenge for the new governor, will be dealing with New Delhi without changing the course RBI has taken in the past few years. For instance, it is clear that the government and some members of the ruling party want interest rates reduced in order to provide momentum to economic growth. The new governor, with the MPC, will have to work with such pressures in the long-term interests of the Indian economy. Differently put, the new governor will have to protect the hard-won credibility of the RBI. This may not be easy in the evolving circumstances. What might help the governor and the MPC here is that India now has a tradition of healthy difference of opinion between the government and the central bank.

News reports suggest that the government will announce Rajan’s successor in August. It will be well advised to make this announcement sooner rather than later to put an end to all manner of speculation and uncertainty on this front.

What are the other challenges that the new central bank governor will have to face? Tell us at views@livemint.com

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