By Corinne Abrams, Debiprasad Nayak and Rajesh Roy

NEW DELHI -- Reserve Bank of India Gov. Urjit Patel resigned Monday citing personal reasons, following months of tension between the central bank and the government.

Mr. Patel and the central bank had come under pressure in recent months from the government over policy, with New Delhi urging the RBI to ease lending rules for state-run banks and transfer surplus funds to the government.

The government had said it was considering invoking a rarely used law that allows it to direct RBI policy, people familiar with the matter said.

The rupee declined during the October tensions amid reports that Mr. Patel was considering quitting over interference from the government over policy. But a central bank board meeting ended last month with Mr. Patel remaining in place.

That made his resignation Monday, "a major surprise," said Madan Sabnavis, chief economist at Mumbai-based Care Ratings. "During the last board meeting, all the issues seemed to have been sorted out," he said.

Mr. Patel quit ahead of the end of his three-year term, which wasn't due until next year. His move comes just a few days before a scheduled meeting of the reserve bank's board on Friday.

"I have decided to step down from my current position effective immediately. It has been my privilege and honour to serve in the Reserve Bank of India in various capacities over the years," Mr. Patel said in a statement.

Mr. Patel successfully kept inflation around the RBI's medium-term target of 4% over the past two years. However, some investors said his focus on improving the health of banks by targeting their bad loans choked liquidity. That worsened after the government stepped in to take over shadow banker Infrastructure Leasing & Financial Services Ltd. in October after it defaulted on debt payments.

"Had he put the country first before the autonomy of RBI, the situation could have been averted," said Deven Choksey, managing director at Mumbai-based broker K.R. Choksey Shares and Securities.

As tensions rose in October, the finance ministry sent letters to the central bank asking it to consider easing lending restrictions on 11 state-run banks that were imposed to help them recover from a buildup of nonperforming loans.

Under the central bank's code, the government can direct the RBI to act if it believes it is in the public interest. The government issued a statement in October saying that it consulted with the RBI in the public interest.

In the same month, Finance Minister Arun Jaitley criticized the RBI for failing to prevent a buildup of bad loans at state-run banks, saying the bank "looked the other way" as banks gave out loans "indiscriminately."

His comments followed a speech by RBI Deputy Gov. Viral Acharya in which he spoke of the importance of the independence of the central bank, which also annoyed the government.

"Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets," Mr. Acharya said in the speech. In a footnote to it, he said that Mr. Patel had suggested the theme of the speech.

The resignation "signals that the government has come out on top in its dispute with the central bank, but at the cost of undermining the RBI's credibility and its inflation-fighting credentials," Mark Williams, chief Asia economist at Capital Economics, wrote in a note distributed after the resignation. "The key question now is who the government appoints in Mr. Patel's place. The most worrying scenario for investors would be if the government appointed someone from the finance ministry."

Prime Minister Narendra Modi and Mr. Jaitley thanked Mr. Patel for his service Monday.

"He steered the banking system from chaos to order and ensured discipline. Under his leadership, the RBI brought financial stability," a tweet on Mr. Modi's official Twitter account said. "We will miss him immensely," another tweet said.

Mr. Patel succeeded Raghuram Rajan as central bank governor in 2016. Mr. Rajan returned to academia after his term ended after he was criticized by the government for being too outspoken on matters other than central bank policy and for not doing enough to boost the economy. He was also credited with arresting the rupee's decline against the dollar and bringing inflation down.

Write to Corinne Abrams at corinne.abrams@wsj.com, Debiprasad Nayak at debi.nayak@wsj.com and Rajesh Roy at rajesh.roy@wsj.com

(END) Dow Jones Newswires

December 10, 2018 10:20 ET (15:20 GMT)

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