One Year Of Urjit Patel: A Governor Who Kept The Markets Guessing

When Urjit Patel was picked to succeed Raghuram Rajan as the 24th Governor of the Reserve Bank of India (RBI), most analysts said the choice would bring continuity. Patel had been Rajan’s deputy governor through his three year tenure. Patel was also the author of a report on a new monetary policy framework which had set the stage for India’s move towards flexible inflation-targeting.

With Patel now in the governor’s chair, the markets took comfort in knowing that there would be continuity in approach. The only fear at the time was that Patel would be a touch more hawkish than Rajan.

The appointment of Urjit Patel as the RBI Governor signalled the “reassertion of policy continuity by policy makers,” wrote India Ratings in a report dated August 22, 2016. Goldman Sachs wrote that Patel was “likely to maintain similar views as Governor Rajan in the inflation targeting, banking sector reforms, overall liquidity, and exchange rate policy areas.” Most commentators towed a similar line.

The year has proved to be an eventful one for both bond and currency markets, although the bouquets and brickbats shouldn’t necessarily go to Patel alone.

Bonds: A Year Of Wild Swings

The first jolt for the bond markets came two months into Patel’s tenure. Demonetisation. It is still not clear whether the RBI was in favor of the decision to scrap 86 percent of currency in circulation or not. But with the Prime Minister announcing the decision on November 8, the Reserve Bank was in the hot seat.

Apart from managing an unprecedented currency exchange program, the central bank was also faced with a deluge of liquidity. Bond yields plummeted on the expectation that banks would need to park all the surplus funds in government securities. But as rates fell to the lowest in over seven years and started to trade below the benchmark repo rate, the RBI stepped in to say that deposits received between September 16 and November 11 would be impounded through the use of the cash reserve ratio. Yields jumped and then settled once the RBI clarified that this was temporary.

Just as the demonetisation shock had settled, came another surprise for the markets. An abrupt change in the monetary policy stance from accommodative to neutral at a time when most economists were still expecting rate cuts.

“Despite lowering both its growth and inflation projections, the RBI changed its monetary policy stance to neutral (from accommodative),” said Nomura Global Market Research in a note while dropping its expectations of any further rate cuts.

Yields surged.

The twists and turns weren’t over. As it became clear that inflation was undershooting the RBI’s own forecasts by a wide margin, bond yields fell again in anticipation of lower rates. This time the RBI didn’t surprise and delivered a repo rate cut in August.

With growth weak, inflation low and a neutral stance, the market is now once again guessing which way the Patel led RBI will go from here.

Also Read: One Year Of Urjit Patel: Some Tough Love For Banks

Has the market found it tough to read the reclusive governor’s mind?

Jayesh Mehta, treasurer at Bank of America-Merrill Lynch does not think so. In his view, communication of monetary policy is now the remit of the monetary policy committee (MPC). Between the statements issued every two months and the minutes of the meeting released as well, the market should have a good sense of the MPC’s thinking, said Mehta pointing to the fact there have been a number of unforeseen events domestically and globally over the last 12 months which could explain the volatility.

Currency Appreciation: By Design Or Lack Of Choice

While the bonds market had a volatile year, the currency markets seemed to be on a rare one-way move up.

The rupee has appreciated nearly 5 percent over Patel’s tenure courtesy strong foreign inflows into both the debt and equity markets. Between September 2016 and August 2017, inflows into the equity markets have added up to Rs 1.17 lakh crore. But that number doesn’t tell the full story. Demonetisation and a change in the direction of fund flows post the election of Donald Trump as the U.S. President led to strong outflows between October 2016 and January 2017. In all other months, flows have been positive.

The central bank has sucked out dollars from the market, but the pace of inflows has meant that despite the intervention the rupee has appreciated more than 6 percent this year. For a currency already in overvalued territory (going by the Real Effective Exchange Rate), the appreciation has not been entirely welcome. But the RBI’s hands are tied. Each time it buys dollars, it infuses rupees into a market where liquidity is already surplus.

As the RBI has sucked out dollars, foreign exchange reserves appear to be on course to hit $400 billion. Reserves, while always welcome, also come at a cost.

Forex reserves are at an all-time high and have risen at the fastest pace since 2015, noted Morgan Stanley economists in a report dated August 17. “With capital flows set to remain buoyant, we believe the central bank continues to face the challenge of excess liquidity challenges and in keeping call rates closer to repo rates,” the report added.

To be fair, most central bankers measure their words extra-carefully when it comes to the currency markets.

Still, the change in direction and the uncertainty over the RBI’s approach has left corporates with a foreign exchange exposure scratching their heads. Jamal Mecklai, a veteran of the foreign exchange markets summed it up well in a report on May 31.

“Some companies are sticking to their historic approach of hedging 50 percent, praying for a sudden bout of weakness; others are just frozen in the market glassy-eyed. But even if there is a sudden tumble, it is very difficult to act because what if what if what if….”