A ceasefire or a fight to the finish?

One doesn’t need to be a soothsayer to predict that the December 5 monetary policy of the Reserve Bank of India (RBI) will be a non-event. But no one is sure what’s going to happen today when the RBI central board meets in Mumbai to discuss issues on which both the central bank and the finance ministry have chosen to wash dirty linen in public through tweets, speeches and selective leaks to media. (I am not getting into the niceties of who hits first and who retaliates.)

Will it be a non-event with both sides living happily ever after? A fight to the finish with RBI governor Urjit Patel resigning or a no-confidence motion being moved against deputy governor Viral Acharya? Or, a ceasefire — a temporary stoppage of a war with both sides agreeing to suspend aggressive actions. 

Watching closely the developments in the run-up to the board meeting, I would like to believe it’s going to be a truce to buy time and sort out the differences. Be that as it may, the relationship between the government and the RBI will never be the same again. There is nothing new in the rift between the two but the scale of the latest round is unprecedented. How things pan out in the future will depend on who is at the helm of the RBI and the profile of the government after the 2019 general elections.

At the core of the dispute is how much capital and reserves should the RBI have on its balance sheet and how much it can pass on to the government (to help bridge the fiscal deficit). Being a lender of the last resort, the RBI needs adequate capital. Indeed, a committee can be set up to look into its economic capital framework, but we need to keep in mind that much of the RBI’s capital is “revaluation” reserve. For instance, since its balance sheet is in rupee and the bulk of the assets is in dollar, when the rupee depreciates, its reserves rise but that’s just an accounting practice.

Illustration by Binay Sinha

The government wants the RBI to dilute its prompt corrective action (PCA) framework which restrains banks from giving loans, among other things. This is slowing down fund flows to the small and medium enterprises. Twelve banks are under the PCA now as they could not meet certain regulatory requirements such as minimum capital, return on asset and pile of bad loans but the framework also allows the RBI to use its “discretion” to loosen certain conditions, depending on the profile of a bank. But, can just a permission to lend translate into lending? Should we force the weak banks to lend? Bank of Baroda, a relatively strong bank, kept on shrinking its loan book from September 2015 till September 2017 (from Rs 4.15 trillion to Rs 3.87 trillion) and started giving fresh loans late last year. 

The focus is also on the RBI’s apparent reluctance to ensure liquidity for the stressed non-banking financial companies (NBFCs). It has eased bank exposure norms to NBFCs and allowed for partial credit enhancement. Besides, Rs 360 billion was infused into the system in October through RBI’s open market operations (bond buying) and another Rs 400 billion will flow in November. Since April, the RBI has pumped in Rs 1.18 trillion till last week; despite that, the liquidity deficit in the system is Rs 1.11 trillion as the liquidity infusion is more than offset by the RBI’s dollar sell (to stem volatility in the forex market) which sucked out at least Rs 2.1 trillion since April.

The government wants the RBI to repeat what it had done to tackle the liquidity crisis following the collapse of Lehman Brothers Holdings Inc but the RBI probably doesn’t see the current situation as grave as it was then and does not mind a few NBFCs paying the price for their irrational exuberance. Between October 2008 and June 2009, the RBI had relaxed the maintenance of banks’ bond holding and opened a special repo window to meet the funding requirements of the NBFCs, mutual funds and housing finance companies. While the context is different, a special facility will help restore confidence like it did in 2008 even though not too many NBFCs used that.

The RBI’s “dissent” on the recommendation of a government panel on changes to payment and settlement laws is already in the public domain. If the media reports are to be believed, there are many more contentious issues. The government, reports suggest, wants the banking regulator to cut the cash reserve ratio (the portion of deposits that commercial banks keep with it) to generate liquidity; pare banks’ capital requirement (so that they can lend), and wants the RBI board to draft regulations for setting up panels to oversee financial stability, monetary policy transmission and foreign exchange management. 

If that’s true, then the government wants the board of the central bank to play a supervisory role as opposed to its current advisory role (even though technically it enjoys “concurrent” power with the governor). The board which currently has 18 directors can have 21, including governor and four deputy governors, two government nominees, four from RBI’s local boards and 10 appointed by the government. The concept of independent director does not exist here and there is no explicit qualification for a director. There are disqualifications though — a government employee, an insolvent person, someone attached to a bank and a mentally challenged person cannot be on the RBI board. Four deputy governors and two government nominees do not have voting rights; in the case of a tie, the governor has the casting vote. In RBI’s history, no resolution has been put to vote ever.

The RBI’s autonomy is defined within a framework where sovereign is the supreme. Legally, there is absolutely nothing wrong if the government “directs” the RBI to do certain things but it’s a question of propriety. There is no difference between the board of a company and that of the RBI — the job is to ensure governance. And like any corporate board, here too the governor needs to convince the directors of the management goals and the directors should be competent and independent, and not aligned. 

Finally, the government is also the majority owner — of about 70 per cent —  of the Indian banking system. Challenging the economic capital framework for transfer of more money is one thing and dilution in bank regulations is another. Shouldn’t regulations be ownership neutral?

The columnist, a consulting editor of Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd.

Twitter: TamalBandyo