THE RBI VS NORTH BLOCK TUG OF WAR
Discontent brews between the RBI and the government as the central bank stamps its independence through policy prescriptions on critical economic issues
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.
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.