Modi’s losses, RBI chief raise populism risk

Narendra Modi, the Indian prime minister, took two big blows in less than 24 hours. Investors should worry less about the bruises, and more about what he might do to recover from them before next year’s general elections.
The first knock came when besieged Reserve Bank of India (RBI)  governor Urjit Patel abruptly resigned. Although he cited personal reasons, nobody is in any doubt that it was New Delhi’s incessant harassment that led to the monetary chief’s early exit. Team Modi, it appears, is out to reshape the RBI, ultimately leaving it with an emaciated balance sheet, little power of supervision over banking and finance firms, and under the thumb of a bunch of bureaucrats.
Why an 83-year-old institution needed such a remaking now became clear in the second punch. Votes counted handed defeats to the ruling party in three key state elections. The fact that Modi’s personal popularity is struggling to pull votes puts a big question mark around the outcome of next year’s parliamentary polls. How does Modi make it right with voters in six months? How does a government that has little fiscal firepower deal with agrarian distress and dismal growth in urban jobs? By getting a credit boom going, of course. With the blessing of a pliant central bank.
That’s where the whack of Patel’s departure is related to the thwack Modi got from voters. What the prime minister might do in response could please speculators, but long-term investors should be nervous. Large corporate balance sheets in India are still under repair. And among the 21 state-run banks, which have the lion’s share of cheap deposits, as many as 11 are facing various degrees of lending restraints as a punishment by the RBI for their prior recklessness.
What Modi needs now is a central bank that will shield errant corporate debtors from bankruptcy, and unshackle
the undercapitalised state-run banks, so they can get together and start a new credit party.
Capital isn’t a problem. After all, it’s not uncommon for the equity in shadow finance companies’ operating companies to be funded via bonds issued by their unlisted holding companies, which are lapped up by Indian mutual funds. The RBI has so far been too caught up with banks to look closely under the hoods of these shadow lenders. Desperate populism doesn’t always need the state’s resources – as long as taxpayers are on the hook to socialise private losses later.
The appointment, after the election results, of Shaktikanta Das, the former finance-ministry bureaucrat who had executed Modi’s draconian currency ban in late 2016, as the next RBI chief. Modi would have known that if Patel’s leaving had done damage to the perception of the RBI’s independence, the naming of Das would do nothing to reverse it. But central-bank autonomy doesn’t win votes. A market-pleasing credit binge just might do the trick.
—Bloomberg

Mihir Sharma covers India for Bloomberg Economics in Mumbai. He previously worked as an economist at DSP Merrill Lynch and as a research analyst at the National Institute of Public Finance and Policy, India’s premier macro/finance think tank