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  Opinion   Columnists  22 Nov 2018  Govt slugfest with RBI finally ends in a draw

Govt slugfest with RBI finally ends in a draw

The writer is adviser, Observer Research Foundation
Published : Nov 22, 2018, 6:39 am IST
Updated : Nov 22, 2018, 6:39 am IST

The RBI has sensibly shown selective flexibility to soothe angry government voices.

The government waved the populist flag of the liquidity woes of the medium, small and micro enterprises (MSMEs) at the RBI.
 The government waved the populist flag of the liquidity woes of the medium, small and micro enterprises (MSMEs) at the RBI.

It was an unequal fight to begin with. Structurally, the Reserve Bank of India (RBI), the nation’s central bank, is squarely under the government’s thumb. The government appoints the governor of the RBI and can curtail his tenure. Two-thirds of the RBI’s board consists of government appointees who are not RBI officials. The government can supersede the entire board of the RBI and appoint another one. It is convention, conviction and convenience that allows the RBI its operational autonomy. In fact, close and frequent consultations to develop a consensus have been the mechanism for exercising such independence.

Given this power imbalance, the David versus Goliath face-off conjured up in the media was farcical. It is true, though, that since the economic liberalisation and adoption of the open economy model in 1991, events have conspired to enhance the informal power of the RBI. Raghuram Rajan, arguably the most flamboyant RBI governor in recent times, who set in motion the deep reforms of banks by tightening prudential oversight, was fond of citing the god of the bond market as the final arbiter of the central bank’s performance.

It is telling that the financial markets took the government-RBI face-off, brewing since last month, with equanimity. Finance minister Arun Jaitley showed who is the boss by publicly putting the RBI in its place in response to deputy governor Viral Acharya’s frank, almost anguished, public outburst on October 26, against governmental interference and in favour of the RBI’s independence. He is widely perceived as mouthing the sentiment, if not the words, of governor Urjit Patel, who despite the jibes at his being the least communicative of all governors, maintained his calm. This was wise because it got him a meeting with the Prime Minister, who thereafter let the warring parties settle their differences bilaterally. Lutyens’ wags say the meeting with Prime Minister Narendra Modi was in Gujarati, over dhoklas, where Mr Patel led Mr Modi through the ropes of central banking.

Governor Patel was heavily criticised in November 2016 for being complicit in the farce of completing the paperwork retrospectively to make demonetisation appear as if it came from the deliberations of the RBI board. By standing up this time to pressure from the finance ministry’s bureaucrats to dilute prudential norms for banks, Mr Patel’s stature has risen significantly. This is ironic as there was no merit to the demonetisation decision, which was conceived without even consulting the RBI. In contrast, some of the proposals of the government in the recent spat have substance.

It makes sense that the framework for maintaining adequate capital in reserve by the RBI should be explicitly debated and decided by the board after consulting the government. After all, the RBI Act states that the entire surplus after meeting the requirement of operational costs and reserves must be transferred to the government. The government thus has a stake in defining prudential limits for the reserves.

Similarly, whether we should equate the capital adequacy norms for banks to the Basel-III norm of eight per cent of risk-weighted assets rather than nine per cent, as is being done now, should be discussed threadbare in conjunction with the timing and red flags for lending constraints to be imposed under Prompt Corrective Action (PCA). Red flags of potential insolvency are increased in the proportion of non-performing assets beyond the owned capital of the bank and reduced or negative profitability.

The government waved the populist flag of the liquidity woes of the medium, small and micro enterprises (MSMEs) at the RBI. It is here that 70 per cent of employment; 40 per cent of GDP and 45 per cent of exports are generated. Commercial bank finance is spottily available for MSMEs since credit risk assessments are tough. It is the non-banking finance companies (NBFCs) which are the primary providers of debt funds for investment purposes to this segment. The government chose its ammunition well. NBFCs are regulated by the RBI. And as the recent bankruptcy of the Infrastructure Leasing and Financial Services Ltd showed, prudential oversight has been grossly inadequate. Loose NBFC regulation is the RBI’s achilles heel and the Centre was ruthless in exploiting this weak spot.

But the finance ministry was ill-advised to start a fight with the RBI with Assembly elections happening in four states. An ugly public spat with the RBI could rake up the question of why the government took time to act on the list of bank defaulters sent to it by Raghuram Rajan. Judicious “leaks” to the media that RBI governor Patel might resign if he was pushed too far added to the pressure on the government to compromise.

Finally, the outrageous demand that the RBI hand over Rs 3.6 trillion, or one-third of its reserves, to the government this fiscal year — six times more than the surplus amount last year — added to the fire. Requiring the RBI to transfer its surplus rather than issue government securities of a similar volume has the optical accounting “benefit” that transfers, unlike new securities, do not increase the fiscal deficit and could help the government keep within the target of 3.3 per cent of GDP. In economic terms, both options will push up money supply and the potential for inflation. But in political terms either is a bonanza. Goodies and freebies are to elections what tadka is to Punjabi dal. Handing over cash equal to just below two per cent of GDP, months before a crucial national election, is akin to giving 1.75 litres of the best whisky to an alcoholic. It is bound to be wasted.

The RBI has sensibly shown selective flexibility to soothe angry government voices. It will consider restructuring (ever-greening) of MSME loans below Rs 250 million each; discuss the capital reserves issue further; consider relaxing the lending constraints for those of the 11 publicly owned banks which provide for their non-performing assets and once they show a profit. To enhance liquidity, it shall buy back Rs 80 billion worth of government securities. The ball is now in the RBI’s court. It is bound to play a slow, measured game till the onset of national elections (India’s favourite spectator sport) consumes all else.

Tags: reserve bank of india, arun jaitley