India Today - - UPFRONT - By Sh­weta Punj with M.G. Arun

Short of shout­ing from the rooftops, Re­serve Bank of In­dia (RBI) of­fi­cials and the gov­ern­ment have made their an­i­mos­ity against each other quite ex­plicit. The un­spo­ken has been spo­ken. No words have been minced. The un­ex­pected has hap­pened and no one seems to know where will it go from here. The un­cer­tainty is mak­ing mar­kets and in­dus­try anx­ious, even as the RBI and Union min­is­ters take to pub­lic plat­forms to set­tle scores.

On Oc­to­ber 26, RBI deputy gov­er­nor Vi­ral Acharya used a lec­ture to launch a scathing at­tack: “Gov­ern­ments that do not re­spect cen­tral bank in­de­pen­dence will sooner or later in­cur the wrath of fi­nan­cial mar­kets, ig­nite eco­nomic fire, and come to rue the day they un­der­mined an im­por­tant reg­u­la­tory in­sti­tu­tion...” His in­dict­ment echoed across the mar­kets and the cor­ri­dors of power. Dis­con­tent be­tween the RBI and North Block had been brew­ing for nearly a year but “Vi­ral’s speech changed the whole pic­ture”, says a macro­econ­o­mist who ad­vises for­eign in­vestors on the In­dia story.

A source at the RBI board meet­ing on Oc­to­ber 23 says Acharya, much to the shock of the mem­bers present, de­clared that the Prompt Cor­rec­tive Ac­tion (PCA) norms were not brought up for dis­cus­sion be­fore the board as they would not have cleared it. The mem­ber, re­quest­ing anonymity, said “the RBI is ask­ing for in­de­pen­dence from the board”.

A min­is­ter in the Modi gov­ern­ment, not want­ing to be named, ex­pressed deep dis­ap­point­ment at the RBI’s ham­handed ap­proach. Ob­servers say that while there was al­ways some ten­sion be­tween the two pol­i­cy­mak­ ing arms of the gov­ern­ment, for it to have reached this pass took sus­tained pres­sure on the RBI over the past year or so on a host of pol­icy de­ci­sions. Gov­ern­ment sources say on as­sum­ing of­fice, the RBI gov­er­nor had agreed to re­visit the pro­vi­sion­ing norms, re­duce in­ter­est rates, ex­tend more sup­port to MSMEs, but didn’t come good on the com­mit­ments.

What rocked the boat is the loom­ing cri­sis in the NBFC (non­bank­ing fi­nan­cial com­pa­nies) sec­tor. With the de­fault of in­fra­struc­ture leas­ing gi­ant In­fra­struc­ture Leas­ing & Fi­nan­cial Ser­vices

(IL&FS), In­dia’s grow­ing shadow bank­ing sec­tor came un­der the spot­light and the pos­si­bil­ity of a crip­pling credit crunch be­came very real. The credit squeeze has been a source of much heart­burn among big busi­ness and small and medium en­ter­prises. In fact, it was to bat for the in­ter­ests of SMEs that swadeshi econ­o­mist S. Gu­ru­murthy was ap­pointed as a di­rec­tor on the RBI board and Nachiket Mor’s ten­ure on the board was cut short. The blame for the IL&FS fi­asco has fallen on the gov­ern­ment and the slide of the ru­pee has given the op­po­si­tion plenty of fod­der too. The RBI, says the gov­ern­ment, should have bet­ter mon­i­tored both. It was no sur­prise that fi­nance min­is­ter Arun Jait­ley coun­tered Acharya’s re­marks by crit­i­cis­ing the RBI for fail­ing to pre­vent lend­ing ex­cesses. “The cen­tral bank looked the other way when banks gave loans in­dis­crim­i­nately from 2008 to 2014,” he said.

This is not the first time the fi­nance min­is­ter has made a case for mak­ing the reg­u­la­tors ac­count­able. In Fe­bru­ary this year, Jait­ley had said, “Reg­u­la­tors ul­ti­mately de­cide the rules of the game and they have to have a third eye, which is per­pet­u­ally open. But un­for­tu­nately in the In­dian sys­tem, we politi­cians are ac­count­able, reg­u­la­tors are not.”

Pa­tel had hit out at this ac­cu­sa­tion on March 14, say­ing, “There has been the usual blame game, pass­ing the buck and a tone of honk­ing, mostly short­term and knee­jerk re­ac­tions. These... have pre­vented the par­tic­i­pants in this ca­coph­ony from deep re­flec­tion...” He went on to point out the cru­cial is­sue of bank own­er­ship, which was the first area of con­flict be­tween the gov­ern­ment and RBI. All com­mer­cial banks in In­dia are reg­u­lated by the RBI, but all pub­lic sec­tor banks are reg­u­lated by the gov­ern­ment and the RBI does not have pow­ers over cor­po­rate gov­er­nance of PSU banks, he said, a point Acharya re­it­er­ated in his speech.

An­other point of con­tention has been the trans­fer of re­serves. The gov­ern­ment has pegged RBI’s ex­cess cap­i­tal at Rs 3.6 lakh crore and has been seek­ing it as sur­plus. But Acharya re­fused, stat­ing: “Hav­ing ad­e­quate re­serves to bear any losses that arise from cen­tral bank op­er­a­tions and hav­ing ap­pro­pri­ate rules to al­lo­cate prof­its is con­sid­ered an im­por­tant part of the cen­tral bank’s in­de­pen­dence from the gov­ern­ment.” He cites for­mer deputy gov­er­nor Rakesh Mo­han on the need for a strong bal­ance sheet. “Raid­ing the RBI’s cap­i­tal cre­ates no new gov­ern­ment rev­enue on a net ba­sis over time and only pro­vides an il­lu­sion of free money in the short term. The use of such trans­fer would erode what­ever con­fi­dence ex­ists in the gov­ern­ment’s in­ten­tion to prac­tise fis­cal pru­dence.”

Third is the is­sue of regu­ la­tory scope. The gov­ern­ment has been push­ing for a sep­a­rate pay­ments reg­u­la­tor, while the RBI has ar­gued that the pay­ment sys­tems are a sub­set of cur­rency, which it reg­u­lates. The RBI says the com­po­si­tion of the Pay­ment Reg­u­la­tory Board is not in con­form­ity with the fi­nance min­is­ter’s an­nounce­ment in the fi­nance bill.

The fi­nal straw has been the NBFC cri­sis. Al­though the gov­ern­ment and the RBI have both in­sisted that liq­uid­ity is not a con­cern, the fact re­mains that liq­uid­ ity needs to go to the right peo­ple. Mar­kets are de­mand­ing a sep­a­rate win­dow for NBFC re­fi­nanc­ing, while the RBI is de­ter­mined to not res­cue com­pa­nies that have lent reck­lessly. The house is di­vided on whose ap­proach is right. Madan Sab­navis, chief econ­o­mist with Care Rat­ings, says: “Re­gard­ing open­ing a win­dow for NBFCs, each sec­tor can come up with the de­mand for such a win­dow. All these will set a prece­dent. A dia­logue is the best way to re­solve the cri­sis and reach a mid­dle ground. For in­stance, in the case of prompt cor­rec­tive ac­tion (PCA), you can make banks lend to only AAA­rated com­pa­nies.” Eleven PSU banks have been put un­der the RBI’s Prompt Cor­rec­tive Ac­tion (PCA) mech­a­nism on breach­ing key reg­u­la­tory re­quire­ments re­lat­ing to cap­i­tal ad­e­quacy norms, re­turn on as­sets and the quan­tum of bad loans. While this will not have any mag­i­cal ef­fect on the fi­nan­cials of these banks, it will at least pre­vent them from amass­ing fur­ther NPAs, since banks un­der PCA are re­stricted from giv­ing out fresh loans. How­ever, this has be­come an­other point of con­flict be­tween the gov­ern­ment and the RBI.

Yet an­other point of con­tention was the RBI cir­cu­lar in Fe­bru­ary this year that stated that any com­pany with even a day’s de­lay in re­pay­ment will be termed a de­faulter. This had in­dus­try up in arms. Power com­pa­nies chal­lenged the cir­cu­lar in the courts and the Supreme Court or­dered a stay, pre­vent­ing ini­ti­a­tion of in­sol­vency pro­ceed­ings against stressed power as­sets.

For now, econ­o­mists and in­vest­ment ad­vi­sors are busy field­ing calls from for­eign in­vestors be­cause no­body ex­pected a break­down of this mag­ni­tude. There are me­dia re­ports that Pa­tel is un­der pres­sure to step down. But if he does, the corol­lary would be that his suc­ces­sor would have to com­pletely toe the gov­ern­ment’s line. If he stays on, the cru­cial is­sues of liq­uid­ity and trust­build­ing will need quick res­o­lu­tion. Most im­por­tantly, if Pa­tel walks away, the per­cep­tion that the Modi gov­ern­ment is un­able to work with econ­o­mists with a dif­fer­ent world view will be stamped rather em­phat­i­cally, com­ing af­ter the abrupt exit of for­mer gov­er­nor Raghu­ram Ra­jan.

While the mar­kets are de­mand­ing a sep­a­rate win­dow for NBFC re­fi­nanc­ing, the RBI is de­ter­mined to not bail out com­pa­nies that have lent reck­lessly. It’s a sore point

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