Reserve Bank of India governor Raghuram Rajan has declared his intention to step down when his term ends in early September.

Reserve Bank of India governor Raghuram Rajan has declared his intention to step down when his term ends in early September. Photo: Pal Pillai

India’s central bank governor Raghuram Rajan said he will step down when his term ends in early September, an unexpected move that came after a key ally of Prime Minister Narendra Modi criticised him for keeping interest rates too high.

In a letter to staff published on Saturday, Rajan listed a range of accomplishments since he took office in 2013, including a shift to inflation targeting, stabilising the rupee and helping with reforms to state-run banks. The 53-year-old said more work was left to be done on reining in inflation and cleaning up the banks.

“While I was open to seeing these developments through, 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,” Rajan said. “I will, of course, always be available to serve my country when needed.”

Finance Minister Arun Jaitley said the government appreciates the work done by Rajan and respects his decision. A successor will be announced shortly on Twitter, he said.

Rajan’s exit risks unravelling sweeping changes to the central bank that he orchestrated since taking office. The former International Monetary Fund chief economist backed efforts to create a monetary policy committee and strongly advocated fiscal discipline to boost India’s credibility with bond investors.

“This is a negative surprise for India,” said Tirthankar Patnaik, a Mumbai-based economist at Mizuho Bank. “In India’s impending macro scenario, Rajan’s presence would have been really, really important. Without him, things are likely to be much more difficult.”

Rajan’s letter on Saturday caught Modi’s government by surprise, according to a person familiar with the situation. The administration saw the consultations between Rajan and Jaitley over his second term as still ongoing, and it has no obvious successor lined up, the person said.

The uncertainty over Rajan’s future has hung over the markets for weeks. When reports of Rajan’s desire to leave the post emerged on June 1, the rupee and bonds fell. The topic of his reappointment came up repeatedly at a conference in Singapore, where “investors unequivocally wanted governor Rajan to continue,” according to a Deutsche Bank report last month.

The timing is “certainly bad” for India due to uncertainties over the monsoon and Brexit, according to Rupa Rege Nitsure, group chief economist at L&T Finance Holdings.

“There will be some nervousness initially but it may not last for very long,” Nitsure said of the market reaction. “Whom they select as the next governor will have a deeper impact on market sentiment.”

Accolades for Rajan poured in on Saturday. Lawrence Summers, a former US treasury secretary, called Rajan “one of the few central bank governors who has changed the regime in a major country”. State Bank of India chairman Arundhati Bhattacharya called Rajan “a person of very high calibre, who has built ably on the reputation of our central bank and given it a very large measure of credibility”.

Rajan took charge of the central bank when the rupee was at a record low and the inflation rate was among Asia’s fastest. After tight monetary policy and a crash in global oil prices helped damp price pressures, he began cutting borrowing costs last year and brought the benchmark rate to a five-year low of 6.5 per cent. He’s now in the midst of a $120 billion clean up of stressed assets in the banking system and helping to establish a new monetary policy committee.

Subramanian Swamy, a member of Modi’s ruling party, sought Rajan’s dismissal for keeping interest rates unnecessarily high and stifling growth. Swamy also called Rajan “mentally not fully Indian” and criticised him for a speech last year that called for tolerance amid a debate about religious discrimination.