By Devidutta Tripathy and Suvashree Choudhury
MUMBAI (Reuters) - India's "rock star" central bank governor Raghuram Rajan, feted by foreign investors but under pressure from political opponents at home, stunned government officials and colleagues on Saturday by announcing he would step down after just one three-year term.
Rajan, a former chief economist at the International Monetary Fund, is held in high esteem by policymakers and investors at home and abroad for overhauling the way the Reserve Bank of India (RBI) operates.
But he has faced mounting criticism from a faction within Prime Minister Narendra Modi's ruling party for keeping interest rates high and over a perception that he had begun to stray into politics.
In a letter to RBI staff, Rajan said he planned to return to academia, even as he noted two of his actions - the creation of a monetary policy committee to set interest rates and the clean-up of the heavily indebted banking sector - remained unfinished.
"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 Sept. 4, 2016," Rajan wrote.
"I will, of course, always be available to serve my country when needed."
It will be the first time since 1992 that an RBI governor has departed after a single three-year term.
A senior government official told Reuters there were seven candidates on an initial long list to replace Rajan.
While there had been some speculation Rajan might not stay for a second term - dubbed "Rexit" in a nod to Britain's vote on European Union membership - government officials said they were surprised by the timing and manner of the announcement.
"Rajan put this in an open letter. It's his decision and we will do what best can be done," said one senior aide to Modi.
Hailed as a "rock star" and "James Bond" by India's media when he was appointed by the previous Congress government in September 2013, Rajan won praise for his sure-footed handling of the country's worst currency crisis in more than two decades.
"The government appreciates the good work done by him and respects his decision. A decision on his successor would be announced shortly," Finance Minister Arun Jaitley said in a tweet on Saturday.
P. Chidambaram, the Congress finance minister who appointed Rajan, said he was profoundly saddened by the decision.
"I am not surprised at all. The government had invited this development through a craftily planned campaign of insinuations, baseless allegation and puerile attacks on a distinguished academic and economist," he said in a tweet.
Rajan, who is on leave from the University of Chicago, had faced strident criticism from right-wing members of Modi's Bharatiya Janata Party, including parliament member Subramanian Swamy, who has waged a campaign against his economic policies.
Swamy, a Hindu nationalist and former Harvard economist, tweeted his delight that Rajan "has said he will go back to U.S. Whatever fig leaf he wants for hiding the reality we should not grudge it. Say goodbye!"
Swamy had described Rajan as "mentally not fully Indian".
Another senior official said Rajan's criticism of rising intolerance in India was seen as direct interference in politics, complicating a decision on whether to re-appoint him.
"I wasn't aware of this and I don't think any of us were," said a senior policymaker who works closely with Rajan. "Looks like the government has taken a decision and he (Rajan) came to know about it and then sent this letter."
Still, Rajan was known to have a good working relationship with Modi, who called the RBI governor a "good teacher" on economic matters, and officials had previously told Reuters that Modi's administration would re-appoint the governor, should he wish to stay on.
Many of Rajan's key accomplishments have come in close collaboration with the Modi government. Rajan pushed for inflation targeting to tackle India's history of volatile prices, which was then made law by the government last year.
Rajan's departure was likely to roil markets on Monday, analysts said, at a time when global factors such as Britain's referendum on European Union membership are already weighing.
"It's a volatile period and as an investor I feel this was unnecessary. His term was ending in September anyway, they could have waited until then," Salman Ahmed, chief investment strategist at Lombard Odier Asset Management in London, said.
"What Mr Rajan wanted was to build a stronger institution and that cannot be one person, the market understands that. What's unnerving is the timing," he said, adding he expected at least a 1.5-2.0 percent fall in the rupee.
"My recommendation to the government is to appoint a successor as soon as possible. Mr Rajan brought a lot of credibility to that post and if we have a name with a similar CV, that will go a long way to reassure markets."
In a move to pre-empt concerns the government lacked a credible field of replacements, the senior official said the candidates on the long list to succeed Rajan included RBI Deputy Governor Urjit Patel and Arundhati Bhattacharya, who is chair of State Bank of India, the country's largest bank.
The others are Vijay Kelkar, Rakesh Mohan, Ashok Lahiri, Subir Gokarn and Ashok Chawla, said the official, speaking on condition of anonymity due to the sensitivity of the matter.
They are mostly veterans of the RBI, the Indian civil service or the two major global financial bodies, the International Monetary Fund and World Bank.
The official played down concerns that Indian markets might swoon on Monday.
"I'll be very frank with you – that is not our assessment," he said. "Our assessment is that, if at all, there would be some mild tremors."
(Additional reporting by Rafael Nam and Euan Rocha in Mumbai, Neha Dasgupta, Rupam Jain, Rajesh Kumar Singh, Manoj Kumar and Douglas Busvine in New Delhi, and Sujata Rao in London; Writing by Alex Richardson; Editing by Rafael Nam and David Clarke)