FINMIN VERSUS RBI
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