5 August 2016
Can India's new central bank head keep the economy on track?
By Ryan Lightfoot-Brown, Research Analyst
In the world of central bank celebrities, we've had our own Bank of England governor Mark Carney compared to George Clooney. In India and further abroad, the enigmatic Dr Raghuram Rajan, the Reserve Bank of India's outgoing governor, is commonly lauded as a 'rock star'.
If his new successor, Dr Urjit Patel, wants the same kind of international acclaim, he will need to continue Rajan’s work in two key areas: banking reform and inflation reduction.
Patel stepped up to the plate today, but he is no newcomer to the central bank. He was previously one of four deputy governors to Rajan and has run the monetary policy department since he joined the bank in 2013.
He has been at the helm of the bank’s ‘inflation targeting’ reform, which essentially means making a target rate of inflation the basis for the country’s interest rate decisions – something most developed nations do as a matter of course. The goal of inflation targeting is to maintain price stability, thereby cementing a strong foundation for all economic development and activity.
This process saw India’s rate of inflation fall from 10.9% in 2013 to 5.9% in 20151. Bringing inflation under control has been a key milestone from international investors’ perspective and the job is not done; India’s central bank recently reconfirmed its target rate of 4% after inflation rose for the fifth month consecutively in July, up to 6.07%2.
This has meant keeping interest rates above where many in India’s government would like to see them, and Rajan has been particularly credited for refusing to bow to pressure on this front. Indeed, championing the independence of the central bank is hailed as another of his achievements.
When Rajan’s retirement from the position of governor was announced, there was speculation his term was not renewed largely due to this issue. Many worried the government would now appoint a more malleable prop who could be encouraged to tow the party line. However, the choice of Patel suggests that is not the case and most analysts are now expecting consistency with Rajan’s policies. In practice, this means significant interest rate cuts are now not expected any time soon.
A second priority area is India’s banking sector. Since Rajan began his stint as governor, he has led the charge, pushing banks—in particular a large state-owned sector—to clean up bad debts and get their balance sheets under control.
The investment opportunity in India’s banking sector is thought to be huge and some estimates suggest it could become the world’s third largest banking sector by 20203. One of prime minister Modi’s earliest initiatives, for example, was to give everyone a bank account, providing access to banking services for the first time to nearly half the country’s population4.
Couple that with India’s demographics of a rising middle class; a youthful, working population; and the government-led, aggressive expansion of the digital banking sector, and the potential looks immense. So are the challenges, however, and growth will be very much dependent on reform.
Once again, Patel’s appointment should hopefully be a positive here, with meaningful changes from the previous regime’s direction not expected. Progress on this front will be something to keep an eye on, however.
For those who are interested in exposure to the Indian growth story, I like the Elite Rated Goldman Sachs India Equity Portfolio. The fund invests in around 80–90 large, medium and small-sized companies, with a focus on finding sound businesses that are set to benefit if the domestic economy booms.
Where to next?
- The tax bill that just made investing in India more exciting
- Investing in India
- How to choose a fund
¹The World Bank data; inflation, consumer prices India; annual 2013–2015
³Frost & Sullivan, Competitive Landscape and Trends in the India Banking Industry, 2014. Report quoted in The Times of India, 21/01/2014
4BBC News, 28/08/2014
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Ryan's views are his own and do not constitute financial advice.
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