A three-line government statement on the night of 20 August, a Saturday, announced Urjit Patel’s appointment as the 24th governor of the Reserve Bank of India (RBI).

“Dr. Urjit R Patel has been appointed as the New Governor of Reserve Bank of India (RBI) for a period of three years with effect from 4th September, 2016. He will replace the present RBI Governor Dr. Raghuram Rajan," read the gist of the statement, which ended two months of fevered speculation over who would succeed Rajan.

The terseness contrasted with the one-page letter Rajan wrote to RBI staff that the central bank put up on its website on 18 June, again a Saturday, chosen obviously to let the financial markets digest the news.

After recapping RBI accomplishments and the unfinished agenda of his tenure, Rajan came to the point in the penultimate paragraph. “...on due reflection, and after consultation with the government, I want to share with you that I will be returning to academia when my term as Governor ends on September 4, 2016." he wrote.

Patel, 52, unlike Rajan, who is a year older and came to the central bank in 2013 after a stint as chief economic adviser, is an insider, having spent almost four years at the central bank.

He is the first deputy governor of RBI in 70 years to be elevated directly to the post of governor. Former governors like C. Rangarajan and Y.V. Reddy also served as deputy governors, but they served out time elsewhere before returning to the central bank as governors.

The appointment of Patel, like Rajan, an inflation hawk, signalled continuity in monetary policy making, offering the markets a sense of relief against the backdrop of all the changes under way in the financial landscape at a time when the central bank is in the midst of a clean-up of bad-loan ridden bank balance sheets.

“Having spent several years at RBI, he is well versed with its internal functioning and can hit the ground running immediately," Pranjul Bhandari and Prithviraj Srinivas, economists at HSBC Securities and Capital Markets (India) Private Ltd, wrote in a 21 August note to clients.

Of course, there’s an unmistakable sense of disappointment, too, among some market participants and businessmen that the governor-designate would not be biased towards cutting rates.

Patel is taking over at a time when the markets are a lot more calm than they were when Rajan moved to the corner office at RBI’s headquarters in Mumbai’s Fort area. Since 4 June 2013 to 4 Sep 2013 (i.e., the three months to the start of Rajan’s tenure) the rupee weakened 15.86% against the US dollar. India was being counted among the so-called fragile five (together with Turkey, Brazil, South Africa and Indonesia) that were being weighed down by massive current account and fiscal deficits.

Yet, Patel’s term won’t be easy. There are a new set of challenges to take on. RBI is moving to a new monetary policy framework, of which Patel has been the key architect. Retail inflation has breached 6% now, the upper tolerance limit of the medium-term target that the government has set RBI (based on the recommendations of a committee headed by Patel). Indian banks are sitting on 6.3-trillion of bad loans and a clean-up initiated by Rajan’s RBI is still on.

Patel has been a key lieutenant of Rajan. First appointed in January 2013 as a deputy governor, eight months before Rajan took the helm, Patel’s term was renewed earlier this year.

Not that he was a stranger to RBI or indeed the government.

When he was at the International Monetary Fund (IMF) in the 1990s, Patel was on deputation to RBI and advised the central bank on issues such as the development of the debt market, the banking sector and pension fund reforms, real exchange rate targeting and evolution of the foreign exchange market.

He was also a consultant to the ministry of finance between 1998 and 2001, and worked on several government committees and task forces, including those on direct taxes, infrastructure, telecom, civil aviation reforms and government pension systems.

A Ph.D in economics from Yale University and an M.Phil from Oxford, Kenyan-born Patel’s career includes stints at the Boston Consulting Group and Reliance Industries Ltd. He was also a board member of Gujarat State Petroleum Corp. Ltd.

While Patel had thus been in and out of policy circles, some believe that he caught the eye of the previous prime minister, Manmohan Singh, after a paper on inflation that he co-wrote with Gangadhar Darbha, who later became an advisor to RBI in 2012.

The paper, called Dynamics of Inflation Herding: Decoding India’s Inflationary Process, criticized the lax attitude of Indian authorities towards combating inflation, which averaged around 9% that year.

“A senior (and serious) official earlier this year described six percent annual inflation as ‘comfortable’ and ‘quiet acceptable’—comfortable and acceptable to whom? Is the suspension of long-standing sound, conservative, inflationary targets temporary, or, is this the new ‘normal’?," Darbha and Patel asked in that paper, which was particularly harsh on then RBI governor D. Subbarao.

Ironically, it was under Subbarao that Patel first became the deputy governor of RBI. When Rajan took over as governor in September 2013, a week later he appointed Patel as the chairman of an expert committee to revise India’s monetary policy framework.

The expert committee under Patel submitted its report in January 2014 and, over the next two years, most of its suggestions have been implemented. The key recommendation—which was adopted early on in the Rajan governorship, and set the tone for monetary policy for the rest of his tenure—was that RBI should adopt an inflation-targeting approach, using consumer price inflation as the monetary policy anchor.

That meant setting a medium-term consumer price inflation target of 4% with a 2 percentage point tolerance level on either side. Given the prevailing retail inflation of close to 8% then, the panel suggested a so-called glide path to the medium-term target.

This became the cornerstone of each policy thereafter, as the graphic shows.

Last month, the government formally notified this inflation target as part of a monetary policy agreement signed with the central bank. RBI will be held accountable for meeting this target. The government also accepted a second key recommendation of the panel: that a committee of the central bank and not the governor take the call on monetary policy.

The search for members of this monetary policy committee is on. In one of his speeches, Rajan had indicated that the first monetary policy review under the next governor could be conducted under the new framework.

It is perhaps fitting that Patel takes over as governor and presides over the monetary policy committee (MPC) which his expert panel had recommended in the first place.

Under the new system, a six-member panel would decide India’s monetary policy, very much like the US Federal Reserve’s Open Market Committee. Three members would be nominated by the government and the rest would be from RBI.

The central bank governor and deputy governor in charge of monetary policy (currently, Patel) are two of the three. Rajan announced that Michael Patra, an executive director, would be the third member.

The government is still searching for its nominees to the committee and is expected to finalize the names by October.

While the governor has a casting vote in case of a 3-3 tie, market participants believe that it is important for Patel to communicate with the government and other members and forge a consensus. “The RBI governor as head of the monetary policy committee needs to build consensus. In the initial period, it is best that decisions are taken by consensus. Else, there is the danger that markets might be gripped by confusion," said A. Prasanna, chief economist at ICICI Securities Primary Dealership.

While the government has notified the 4% +/-2 percentage points band, it amounts to a wide range of 2-6%. While Patel himself is said to be very keen of keeping inflation as close to 4% as possible, there might be others who view an inflation rate of 5.5% as acceptable. Ensuring the smooth functioning of the monetary policy would be one of the key challenges for Patel, a man of few words who is said to prefer working in small groups.

He will have to convince and persuade the other members who might have a differing view and different motivations when it comes to inflation targeting.

The current scenario would make the first MPC meeting (if it happens in October) particularly interesting. Retail inflation for July breached the 6% mark, the upper tolerance limit prescribed by the monetary policy agreement. While recent inflationary pressures, which have been led by higher food prices, may subside on the back of bountiful monsoon rains, the August monetary policy statement highlights risks as well.

“The prospects for inflation excluding food and fuel are more uncertain; if the current softness in crude prices proves to be transient and, as the output gap continues to close, inflation excluding food and fuel may likely trend upwards and counterbalance the benefit of the expected easing of food inflation," the statement said.

In his first monetary policy statement in October, Patel would need to assess if RBI’s accommodative stance must change. The first policy would also offer clues on how RBI under Patel would act to contain inflationary pressures and how tightly it would interpret the 4% medium-term target despite his personal reputation as an inflation hawk.

In any case, it wouldn’t be an easy task to reach 4%, given India’s persistent struggles to contain food inflation. This category, with a 45% weight in India’s Consumer Price Index (CPI) basket, has slipped below 4% in only four months since the series started in January 2012. “There is a certain stickiness (in inflation) around 5%. The journey from 5% to 4% won’t be easy, " cautions Abheek Barua, chief economist at HDFC Bank Ltd.

That said, market participants do expect RBI to continue to move system liquidity to as close to a neutral position as possible to help rate transmission. While initially, in keeping with the Patel committee recommendations, RBI had kept liquidity in a deficit mode, in the April policy, it changed stance so that policy rate cuts are on-passed to bank lending rates.

While system liquidity spilled into a surplus mode in recent times, it is owing to seasonal factors. In an analyst conference call, Patel said the move to a neutral position could be completed in a year or two.

“The true test of inflationary targeting for both Dr Patel and RBI will be when inflation goes up. After some time, if commodity prices go up and when the growth recovery gains traction, price pressures will start building up. It is safe to say that this will happen in the next three years. That is when RBI’s inflation fighting credentials will be forged," Prasanna said.

The other big test for RBI under Patel would be a continuation of the bank clean-up started by Rajan. A special asset quality review in October to December last year brought several skeletons tumbling out of bank closets.

Bad loans across the 40 listed banks in India increased from 4.38 trillion at the end of December to 5.8 trillion at the end of March. Currently, they stand at 6.3 trillion.

The bad loans are a legacy of an economic downturn that, coupled with delays in securing regulatory approvals and completing land acquisition, stranded many large industrial projects, squeezing corporate cash flows and making it difficult for developers to repay loans.

This huge pile of toxic assets has been amassed despite RBI’s repeated and, some say, out-of-the-box interventions to solve this problem. From the formation of joint lender forums to speed up recognition and resolution of stressed assets to debt restructuring schemes, nothing has worked.

The key question in the minds of investors would be what more the central bank could do to clean up corporate balance sheets. It is especially pressing because industrial credit growth has slowed and several state-owned banks have very low capital adequacy ratios.

“The more structural problem to address would be reviving the credit cycle by improving the health of the banking system," Citigroup economists led by Samiran Chakraborty wrote in a 23 August note.

Cleaning up bank balance sheets is a test of time. The first challenge for Patel will be to ensure there is not much volatility in the rupee over the next few months. From September to December, outflows of $24 billion are expected as non-resident Indians withdraw their deposits (which had been solicited in the first place to tackle a falling rupee). While that seems to have been adequately covered with RBI buying dollar forwards, it nevertheless needs to be closely monitored.

A good part of what lies ahead for Patel is work that spills over from the Rajan era and even earlier. Deepening of the corporate bond market, regulating new markets such as peer to peer lending and separating government debt management from RBI’s ambit would be the key regulatory changes that will be part of his focus, market participants say.

Patel, himself, is yet to make a statement outlining his agenda, perhaps waiting for the day when he takes over. However, a paper written by Amartya Lahiri and Patel in December 2015 offers some clues on how he sees the path ahead for central banking.

“For the central bank, the tasks ahead are twofold. First, perhaps, re-balance the reform agenda from high-profile subjects such as legislative amendments…like a monetary policy framework and associated institutional changes, to addressing policy-induced distortions that undermine monetary policy efficacy and transmission. Second, address the challenge of multiple roles/objectives and limited instruments."

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