Government eyes growth, polls; RBI’s focus is on stability

Friction between the government and the central bank is nothing new, nor unique to India. Historically, there have always been differences of opinion, at times quite serious too, between the RBI and the central government. But the extent of current rift and its public nature which has led to frosty relations between the two is unprecedented. All it took for the toxic dispute over monetary policy and who controls the central bank’s reserves to spill into public domain was a hard-hitting speech by a top RBI official on October 26. This blew the lid off the acrimonious fight between the two over a host of issues, including RBI’s autonomy.

Last Wednesday, media reports claimed that the government has invoked powers under section 7 of the RBI Act to issue directions to the central bank in matters adhering to the public interest. This was followed by reports claiming that the central bank governor could resign amid a worsening relationship with the government. As the rift widened over the RBI’s autonomy being questioned after the Centre initiated consultations under section 7, which led to declines in rupee and government bond prices, the government issued a statement supporting the autonomy of the central bank within the framework of the RBI Act, adding that the extensive consultations between the two entities is a common place.

‘Both the government and the central bank, in their functioning have to be guided by public interest and the requirements of the economy,’ the statement said. Tensions between the RBI and the government have been brewing for some time. Since the Punjab National Bank scam was unearthed in February, the government has blamed the RBI for lapses in public sector banks. On the other hand, the RBI governor has hit back at the government for not having enough powers or control over state-run banks. What triggered the firestorm now is the government’s decision to invoke never-before-used powers, on issues ranging from liquidity for non-banking financial companies (NBFCs), capital requirement for weak public sector banks and lending to small to medium enterprises (SMEs) which gave a new twist to the simmering skirmishes.

The rift widened further and tension spilled into public sphere after RBI deputy governor Viral Acharya said in a speech that undermining central bank independence could be ‘potentially catastrophic’, indicating that the RBI was pushing back hard against government pressure to relax its policies and reduce its powers ahead of the 2019 election. He went on to compare the government’s ‘myopic’ economic policies to a T20 cricket match, in contrast to the long-term planning of a central bank, which he called a Test match. This re-kindled the old debate about the central bank’s autonomy in conducting monetary policy, managing the government debt and regulating payments sector. FM Arun Jaitely’s rebuttal, questioning the central bank’s role in the bad loan crisis that’s gripped the state-run banks saying the regulator hadn’t done enough to prevent indiscriminate lending, underlined that relations between the central bank and the government are the coldest they have ever been.

Many a time, the government and the RBI can have objectives that are at odds: the former may want a policy environment that’s more conducive to growth, while the latter may be focussed more on maintaining financial stability and containing inflation. Acharya’s analogy in comparing government’s approach to a T20 match and that of the central bank to a Test match may not be entirely inappropriate: elected governments often have a short-term view, while a central bank takes a long-term view to ensure system stability. This often leads to tension and friction between the two. Remember the displeasure former finance minister P Chidambaram expressed with the monetary policy stance adopted by D Subbarao? Chidambaram had said his government ‘would walk the path of growth alone’ if the RBI was not inclined to cut interest rates. This was between 2011 and 2013 when the RBI raised policy rates, while the government was pitching for a rate cut.

There are several issues over which the RBI and the current government haven’t been seeing eye-to-eye: curbs on poorly performing banks, liquidity provisions for NBFCs, an independent payment regulator, bad loan recognition rules, dividend paid by RBI to the government and oversight of state-owned lenders. While the government wants RBI to open a special liquidity window for NBFCs, relax lending restrictions on 11 weak state-run banks and be lenient on loans to micro, small and medium enterprises, it also wants the central bank to part with some of its reserves or increase its dividend to the government. However, the RBI has a different view on these issues. The question is: should the government whittle RBI’s independence and coerce it to fall in line?

The RBI is not statutorily independent, though it has enjoyed broad autonomy in regulating the banking sector. There are always areas of conflict between the government and the RBI; earlier they were resolved amicably through the process of interaction and dialogue. Why there seems to be a breakdown now because the government wants RBI to either accommodate or compromise on issues that go against the grain of a banking regulator. The RBI governs and regulates several financial and monetary operations that provide systemic stability to economy. Asking the RBI to ease up on its prompt corrective action rules which restrict 11 public sector banks sitting on huge NPAs and pushing the central bank to open the tap to facilitate easy lending to cash-crunched NBFCs is like asking the banking regulator to be little more reckless and look the other way.

So, why is the government, even after publicly censuring the RBI for allowing banks to lend recklessly earlier, now asking the central bank to go easy on lending curbs? It is because the economy is showing signs of a slowdown and the government wants an increase in credit flow to boost growth. The government also wants a share of the RBI’s reserves because it will give the government spending room without impacting the fiscal deficit. That explains the government’s desperation to invoke neverbefore-used powers. Don’t forget that assembly elections in five states are scheduled to take place in NovemberDecember; they will be followed by general election in the first half of 2019. The time has come for the government to announce sops and freebies and list its achievements to voters, and even if some of its actions impact the real economy and create a bigger mess for banks. Didn’t Acharya say no government thinks beyond five years or less, because of the election cycle?