Dis­content brews be­tween the RBI and the gov­ern­ment as the cen­tral bank stamps its in­de­pen­dence through pol­icy pre­scrip­tions on crit­i­cal eco­nomic is­sues

India Today - - THE BIG STORY RBI - By Sh­weta Punj

WWHAT DID THE RE­SERVE BANK OF IN­DIA (RBI) AD­VISE THE GOV­ERN­MENT on de­mon­eti­sa­tion? What­ever the coun­sel, the ver­dict on its suc­cess or fail­ure is out in the cen­tral bank’s an­nual re­port re­leased on Au­gust 29. It states that 99.3 per cent of the de­mon­e­tised notes, worth Rs 15.3 lakh crore, have re­turned to the bank­ing sys­tem. The re­port is a ma­jor em­bar­rass­ment for the gov­ern­ment, for it had ar­gued that de­mon­eti­sa­tion was a bold move to­wards a less-cash econ­omy and would widen the tax base and serve as a blow to ter­ror­ism and black money. De­mon­eti­sa­tion ren­dered 86 per cent of In­dia’s cur­rency il­le­gal and left the RBI strug­gling to cope with the af­ter­math. Ill-pre­pared to deal with a pol­icy tran­si­tion of this scale, the bank kept an­nounc­ing mea­sures and then re­vok­ing them and was vil­i­fied as the ‘Re­verse Bank of In­dia’. This was per­haps the begin­ning of the RBI’s rocky re­la­tion­ship with the fi­nance min­istry. Two years on, the split be­tween the two arms of eco­nomic pol­i­cy­mak­ing is out in the open.

In June 2018, when Piyush Goyal, then act­ing Union fi­nance min­is­ter, met econ­o­mists and mar­ket traders at the Ma­ha­rash­tra gov­ern­ment guest­house in Mum­bai to dis­cuss how to lift the econ­omy to 10 per cent growth, he be­gan with a caveat—any­thing could be sug­gested as long as it didn’t in­volve the RBI. When the is­sue of ris­ing in­ter­est rates came up, he again said that, on con­cerns such as these, it was the RBI that needed to be ap­proached. To those at­tend­ing the meet­ing, this was in­dica­tive of the stress­ful dy­namic be­tween the RBI and the fi­nance min­istry. Now, the lat­est move of ap­point­ing Swadeshi Ja­gran Manch co-con­venor and RSS ide­o­logue S. Gu­ru­murthy to the RBI board is be­ing viewed as a des­per­ate at­tempt by the gov­ern­ment to bring the cen­tral bank on the same page on key eco­nomic is­sues, es­pe­cially the avail­abil­ity of cap­i­tal to medium and small scale en­ter­prises (MSMEs).

Ex­perts are con­cerned that at a time when In­dia and the world are brac­ing for eco­nomic storms un­leashed by trade sanc­tions, hy­per-pro­tec­tion­ism and steep oil prices, the two ma­jor in­sti­tu­tions are out of step with each other. Of late, the RBI and the fi­nance min­istry have been en­gaged in a war of words on var­i­ous is­sues, such as more pow­ers to the cen­tral bank, norms to tackle bad loans, in­ter­est rates and trans­fer of re­serves. It is widely spec­u­lated that the gov­ern­ment is in a bind over the

RBI’s in­de­pen­dence. What doesn’t help the RBI’s case is that, for the first time since 1990, it doesn’t have any­one at the gov­er­nor or deputy gov­er­nor level with any sig­nif­i­cant ex­pe­ri­ence of work­ing with the fi­nance min­istry. Iron­i­cally, the gov­ern­ment makes these ap­point­ments.

Tough res­o­lu­tion

The most re­cent and con­tentious is­sue is a sweep­ing cir­cu­lar the RBI re­leased in Fe­bru­ary 2018, scrap­ping all bad loan re­struc­tur­ing schemes and spec­i­fy­ing new norms that re­quire lenders to clas­sify a loan as non-per­form­ing even if there is a day’s de­lay in re­pay­ment. It also man­dated banks to work out a res­o­lu­tion plan within 180 days of the de­fault, fail­ing which the bor­rower would be re­ferred to the bank­ruptcy courts. This move, it is feared, will throt­tle even com­pa­nies striv­ing to come out of the red through a debt re­struc­tur­ing process. Union min­is­ter for road trans­port and high­ways Nitin Gad­kari said ac­tion against ev­ery de­fault­ing en­tre­pre­neur would af­fect eco­nomic ac­tiv­ity and dis­cour­age en­trepreneur­s.

The liq­ui­da­tion of a large num­ber of as­sets would have meant loss of em­ploy­ment and pro­duc­tive as­sets and a blow to en­trepreneur­ship. The bankers started lob­by­ing with the gov­ern­ment for some re­lief or a new ap­proach to deal with bad loans rather than depend­ing solely on the rigid In­sol­vency and Bank­ruptcy Code (IBC). In fact, the big­gest union of state-run banks filed a writ pe­ti­tion in the Delhi High Court, chal­leng­ing the RBI’s cir­cu­lar on bank­ruptcy pro­ceed­ings.

The All In­dia Bank Of­fi­cers’ Con­fed­er­a­tion, which rep­re­sents 300,000 pub­lic sec­tor bank em­ploy­ees, says the pro­vi­sion will cause losses to the tune of Rs 1 lakh crore and threaten the vi­a­bil­ity of banks. The In­de­pen­dent Power Pro­duc­ers As­so­ci­a­tion of In­dia, too, has chal­lenged the cir­cu­lar as a vi­o­la­tion of Ar­ti­cles 14 and 19 of the Con­sti­tu­tion. Power pro­duc­ers say the cir­cu­lar fails to draw a dis­tinc­tion be­tween var­i­ous forms of stressed as­sets from dif­fer­ent in­dus­trial sec­tors. On Au­gust 27, the Allahabad High Court de­clined to give pri­vate power firms any in­terim re­lief on the RBI cir­cu­lar. The court sug­gested the gov­ern­ment em­ploy a spe­cial dis­pen­sa­tion never used be­fore to give di­rec­tions to the RBI. The is­sue will come up in the Supreme Court on Septem­ber 4. RBI back­ers ar­gue the cir­cu­lar only com­ple­ments the IBC. They add that the RBI has been mind­ful of the im­pact on MSMEs and has eased the non-per­form­ing as­sets (NPA) clas­si­fi­ca­tion norms for smaller com­pa­nies. NPA recog­ni­tion for GST and non-GST MSMEs was ex­tended to 180 days for dues up to De­cem­ber 31, 2018.

The Sashakt op­tion

In June, the gov­ern­ment an­nounced the Sashakt res­o­lu­tion scheme to tar­get bad loans. For as­sets over Rs 500 crore, the scheme aims to cre­ate one or mul­ti­ple as­set man­age­ment com­pa­nies, while an in­ter-cred­i­tor agree­ment frame­work will be cre­ated to speed up the res­o­lu­tion of stressed as­sets un­der Rs 500 crore. For loans un­der Rs 50 crore, a res­o­lu­tion plan would be worked out within 90 days of de­tec­tion of stress by in­di­vid­ual banks.

Within days of the an­nounce­ment, in an ap­par­ent con­cil­ia­tory move, the RBI ap­proved a host of in­ter-cred­i­tor agree­ments be­tween banks. The agree­ments bind mi­nor­ity lenders into im­ple­ment­ing a loan re­struc­tur­ing pro­posal if 66 per cent lenders agree to it. The gov­ern­ment, how­ever, has missed the Au­gust 27 dead­line in the RBI cir­cu­lar to de­clare bor­row­ers de­fault­ers and be­gin in­sol­vency res­o­lu­tion.

Many in the gov­ern­ment be­lieve the Fe­bru­ary cir­cu­lar could have cat­a­strophic con­se­quences. The tight­ened norms will push more banks into the Prompt Cor­rec­tive Ac­tion (PCA) frame­work. With 11 banks un­der the PCA frame­work—that’s nearly half the listed gov­ern­ment-owned banks—and six more at risk of be­ing in­cluded, nearly 50 per cent of the avail­able credit is out of bounds. The crit­i­cism is that the RBI has taken a very me­chan­i­cal ap­proach. Many busi­nesses that are go­ing through gen­uine prob­lems of a low busi­ness cy­cle are get­ting brack­eted among the de­fault­ers.

At a time when the gov­ern­ment wants to push credit growth and spend­ing, and most of the in­vest­ments in the past two years have been gov­ern­ment-driven, a credit squeeze

Un­for­tu­nately, in the In­dian sys­tem, we politi­cians are ac­count­able, the reg­u­la­tors are not ARUN JAITLEY Fi­nance Min­is­ter

There has been the usual blame game, pass­ing the buck and a tone of honk­ing, mostly short-term and knee-jerk re­ac­tions URJIT PA­TEL RBI Gov­er­nor

could be some­thing of a calamity. Cor­po­rate off­take has been low, with a host of growth sec­tors—tele­com, power, to name a few—un­der stress. In­dia has wit­nessed a sharp de­cel­er­a­tion in credit growth in re­cent years. Ac­cord­ing to an HSBC re­port, lend­ing ac­tiv­ity is not ex­pected to pick up any­time soon de­spite rea­son­able progress in bank re­cap­i­tal­i­sa­tion. More banks en­ter­ing the PCA frame­work means ini­ti­a­tion of bank­ruptcy pro­ceed­ings against more de­fault­ers, which will put the al­ready strug­gling Na­tional Com­pany Law Tri­bunal un­der more pres­sure.

Due to lim­ited NCLT benches, bad loan cases un­der IBC are not get­ting re­solved on time. “The po­lit­i­cal po­si­tion­ing of de­bar­ring pro­mot­ers with one-year de­fault from bid­ding for their own as­sets im­pacted the re­al­i­sa­tion or value as other bid­ders (funds and strate­gic play­ers) were not ready to pay more,” says a banker. In a ‘soft­en­ing’ of stance, the gov­ern­ment al­lowed home buy­ers to have a say in the re­vival or re­struc­tur­ing process and ex­empted MSME pro­mot­ers from the one-year de­fault, ef­fec­tively al­low­ing them to bid for their as­sets.

How­ever, sev­eral ex­perts back the RBI’s pre­scrip­tion for bad loans. “It’s a bit like un­der­go­ing chemo­ther­apy. Ob­vi­ously, some bankers are not happy, but an­a­lysts are. From an­nounc­ing as­set qual­ity re­views of banks to fur­ther tight­en­ing of norms for bad loans, a lot of ac­tion has been taken,” says a bank­ing ex­pert who has stud­ied the RBI for the past four decades. “How­ever, this is the worst phase in terms of bank­ing in In­dia. Fifty per cent of the banks have stopped lend­ing. This hasn’t hap­pened in three decades. An in­vest­ment-led econ­omy re­quires credit. We need a fully func­tion­ing bank­ing sec­tor.”

The other is­sue has been the trans­fer of re­serves or div­i­dends. The gov­ern­ment has been un­happy over the div­i­dend the RBI paid it in 2016-17. The RBI had trans­ferred Rs 30,659 crore of its sur­plus to the gov­ern­ment, which was less than half of the Rs 65,900 crore it trans­ferred in 2015-16. Typ­i­cally, the RBI would trans­fer 90 per cent of the prof­its to the gov­ern­ment. For­mer RBI gov­er­nor Raghu­ram Ra­jan took the thresh­old to 99 per cent.

Present gov­er­nor Urjit Pa­tel, how­ever, trans­ferred 87 per cent of the prof­its last year. The RBI has been in­sist­ing on the need to build re­serves again and is now study­ing the fea­si­bil­ity of a pol­icy that will re­quire it to trans­fer a pre-de­ter­mined por­tion of its prof­its. In a sign of con­cil­i­a­tion, on Au­gust 8, the RBI de­cided to pay Rs 50,000 crore as div­i­dend to the gov­ern­ment for the fi­nan­cial year 2018—sig­nif­i­cantly higher than the pre­vi­ous year—in line with the bud­get es­ti­mates.

In­ter­est rates have been another cause of heart­burn for the gov­ern­ment. One view is that the RBI could have re­duced in­ter­est rates more ag­gres­sively when oil prices were low and in­fla­tion wasn’t a dom­i­nant con­cern. But it re­mained cau­tious. In­ter­est rates went down from 8 per cent in 2013 to 6 per cent in 2017 while in­fla­tion was in dou­ble dig­its in 2013, head­line in­fla­tion below 4 per cent from Novem­ber 2016 to Oc­to­ber 2017 and food in­fla­tion av­er­aged around 1 per cent from April to De­cem­ber 2017. There is a sense in the gov­ern­ment that the RBI could have cut in­ter­est rates by 50-75 ba­sis points post-de­mon­eti­sa­tion as banks were flush with liq­uid­ity and in­fla­tion was at 4 per cent.

Vivek De­he­jia, a se­nior fel­low in po­lit­i­cal econ­omy at the IDFC In­sti­tute, Mum­bai, says: “Gov­ern­ments love low in­ter­est rates. The RBI’s man­date is to main­tain in­fla­tion tar­get­ing, so there’s built-in fric­tion. One of the least spo­ken about re­forms is the ac­cep­tance of the agree­ment of the Mone­tary Pol­icy Com­mit­tee of In­dia (MPCI). This is very im­por­tant as there will al­ways be po­lit­i­cal pres­sure to lower in­ter­est rates.”

Set up in 2016, the MPCI has been a de­fin­i­tive step to­wards mak­ing the de­ter­min­ing of in­ter­est rates more in­clu­sive and trans­par­ent, adding to the RBI’s au­ton­omy. The com­mit­tee is headed by the RBI gov­er­nor, with six mem­bers—three from the RBI and three nom­i­nated by the gov­ern­ment. The MPCI has en­sured that the RBI gov­er­nor alone is not held ac­count­able for in­ter­est rates. In Fe­bru­ary this year, the RBI’s MPCI voted 5-1 to keep the repo rate un­changed at 6 per cent, the third con­sec­u­tive pol­icy re­view in which the cen­tral bank kept the rate un­changed.

In June last year, a con­tro­versy erupted when the fi­nance min­istry in­sisted on meet­ing MPCI mem­bers be­fore the mone­tary pol­icy re­view. “All MPCI mem­bers de­clined the re­quest,” Gov­er­nor Pa­tel said at the cus­tom­ary me­dia in­ter­ac­tion. Arvind Subramania­n, then chief eco­nomic ad­vi­sor, said the dip in growth and fall­ing in­fla­tion war­ranted sub­stan­tial mone­tary pol­icy eas­ing. On Au­gust 1, the RBI re­sorted to a back-to-back in­ter­est rate hike for the first time in al­most five years to curb in­fla­tion and pre-empt a rout of the ru­pee as the global trade war es­ca­lated. The MPCI voted 5-1 to raise pol­icy rates by 25 ba­sis points to 6.5 per cent.

Pass­ing the buck

Pa­tel, an NDA gov­ern­ment pick, has had a tur­bu­lent re­la­tion­ship with the fi­nance min­istry. Mat­ters wors­ened this year with dia­man­taire Ni­rav Modi’s Rs 11,300 crore de­fraud on the Pun­jab Na­tional Bank com­ing to light as fi­nance min­is­ter Arun Jaitley put the blame on the RBI. “Reg­u­la­tors ul­ti­mately de­cide the rules of the game and reg­u­la­tors have to have a third eye, which is to be per­pet­u­ally open. But un­for­tu­nately, in the In­dian sys­tem, we politi­cians are ac­count­able, the reg­u­la­tors are not,” Jaitley said in New Delhi on Fe­bru­ary 23.

Pa­tel hit back on March 14. “There has been the usual blame game, pass­ing of the buck and a tone of honk­ing, mostly short-term and knee-jerk re­ac­tions. These ap­pear to have pre­vented the par­tic­i­pants in this ca­cophony from deep re­flec­tion and soul-search­ing,” he said. He added that pub­lic sec­tor banks are reg­u­lated by the gov­ern­ment. The RBI’s de­mand for pow­ers to reg­u­late pub­lic sec­tor banks makes the gov­ern­ment un­com­fort­able as it would mean ced­ing some of its con­trol over money that has been feed­ing the econ­omy. The gov­ern­ment says the RBI has enough pow­ers to deal with prob­lems in all banks.

What makes the sit­u­a­tion com­bustible is that while the RBI is the bank­ing reg­u­la­tor, the gov­ern­ment is the bank owner. This dy­namic doesn’t ex­ist any­where else ex­cept China. Sep­a­rate leg­is­la­tions for pub­lic and pri­vate sec­tor banks, a dif­fer­ent law for for­eign banks and a sep­a­rate leg­is­la­tion for the State Bank of In­dia only com­pli­cate reg­u­la­tory and gov­er­nance mat­ters fur­ther.

Pa­tel is known to have reg­u­lar meet­ings with the Prime Min­is­ter’s Of­fice (PMO), but poor bench strength in the fi­nance min­istry is also cited as a pos­si­ble rea­son why he, un­like his pre­de­ces­sors, has failed to build stronger re­la­tion­ships in the North Block. In its first four years in power, the gov­ern­ment has not had a full­time fi­nance min­is­ter for more than a year. Even an in­for­mal com­mu­ni­ca­tion chan­nel be­tween the fi­nance min­istry and the RBI is ef­fec­tively closed. With the econ­omy go­ing through a com­pli­cated phase—the ru­pee is un­der pres­sure, in­fla­tion is grow­ing, fac­tory out­put is de­clin­ing and the world is be­com­ing in­creas­ingly pro­tec­tion­ist—these are not ex­actly tran­quil times.

Pub­lic trust in the In­dian bank­ing sys­tem is per­ilously low. Be­sides the scams and mis­man­age­ment post de­mon­eti­sa­tion, there were fears that the Fi­nan­cial Res­o­lu­tion and De­posit In­sur­ance Bill would di­lute the in­sur­ance pro­tec­tion of de­pos­i­tors’ money. For now, the gov­ern­ment has dropped the bill. The tug-of-war be­tween the RBI and the fi­nance min­istry is only mak­ing mat­ters worse. The PMO, though, is ex­plicit about the RBI’s au­ton­omy. But, as a macro in­vestor asks, “If the ru­pee were to fall to Rs 72 to a dol­lar, who needs to make a state­ment? The RBI gov­er­nor, the PM or the fi­nance min­is­ter?” It’s im­per­a­tive that this con­fu­sion gets cleared at the ear­li­est, es­pe­cially when the econ­omy is pass­ing through chal­leng­ing times.

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