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India c.bank chief term ends soon, extension possible

MUMBAI - India's central bank chief, Yaga Venugopal Reddy, is due to step down in early September when his five-year term ends, and speculation is mounting over whether he will stay on or someone else will take over the mantle.

Whoever it is will have a challenge on their hands: inflation is at a 13-year peak, growth is cooling from a blistering 9 percent and the public purse is strained by mounting subsidies.

Not only that, the state-dominated banking sector is due for a review about more foreign participation next year and India has set itself the task of allowing greater convertibility for the rupee -- a tall order for a $1 trillion economy in transition.

‘Whether it's going to be Reddy or somebody else, the key focus is going to be managing India's elevated growth momentum while keeping a lid on inflation,’ said Rajeev Malik, head of India and ASEAN economics at Macquarie Capital Securities.

Indian media have speculated Reddy, 66, may be offered an extension, with the government keen for stability as it heads into elections sometime in the next nine months.

India is due to hold elections by May 2009 and an extension would give the next government time to find another candidate if it wanted.

If Reddy steps aside now, there are at least three possible contenders for the post: his deputy Rakesh Mohan, Finance Secretary D. Subbarao or India's executive director at the International Monetary Fund, Adarsh Kishore. Please double-click on [ID:nBOM2005]

Reddy's term ends on Sept. 5 and a decision is expected soon.

According to convention, there is no restriction on the number of terms a central bank governor can hold and no limit on the number of years the term can be extended.

STEERING THE SHIP

For the markets, the priority will be keeping India's liberalising economy on an even keel, something many analysts say Reddy has broadly managed in the face of high growth and turbulence across the world following the US subprime crisis.

‘Despite very substantial increase in economic activity, external engagement and investments, there is still a lot of stability,’ said Ajit Ranade, Aditya Birla group chief economist.

Growth has averaged 8.8 percent under his stewardship and his five years have been marked by steady monetary tightening.

Unlike some central banks which target inflation, the Reserve Bank of India aims to promote expansion alongside price and financial stability, with the country keen to grow as quick as it can to create jobs and lift hundreds of millions out of poverty.

Inflation has spiralled to 12 percent this year, in part due to greater demand than the central bank anticipated but largely due to a surge in oil and commodity prices the world over.

‘The inflation problem is just not an India-specific problem, it's a global problem. We need to look at it in that context,’ said Rob Subbaraman, economist at Lehman Brothers in Hong Kong.

After aggressive monetary tightening in June and July, which took the lending rate to 9.0 percent, its highest in seven years, economists say the RBI is now serious about fighting inflation.

Furthermore it tightened provisions for bank lending to property markets well before the global credit crisis flared.

‘The RBI was quite pre-emptive in that respect on those prudential measures. The US Fed could have taken a few leaves out of the RBI's book in hindsight,’ Subbaraman said.

Credit Lyonnais Securities Asia strategist Chris Wood agrees.

‘The RBI is the only bank I'm aware of which has most clearly articulated its stance in recent years of targetting monetary policy around credit growth and asset prices and not just focusing on CPI (consumer prices),’ Wood said.

As well as inflation, loose fiscal policy risks making monetary policy challenging. Subsidies to offset higher fuel prices, a pay increase for government employees and a farm debt waiver are expected to swell the overall fiscal deficit.

India set itself a roadmap in 2006 of making the rupee INRIN more convertible on the capital account. Reddy, a long-term civil servant and former RBI deputy governor, has taken some steps by easing overseas investment and remittance rules.

His successor must take this and other financial reforms on.

‘The reform agenda, especially for critical and overdue changes in the financial sector, remains uncertain both in terms of design and the timing of implementation,’ Macquarie's Malik said.

‘The government and the central bank need to work together to find the most effective way of pursuing these reforms.’