Sniff? Yes. Paws? No.

The RBI isn't inviolate. But the government must remember a maxim: "Nose in, paws out". Ask questions; critique; but hands off the till

In the past, there have been some contentious meetings of the central board of the Reserve Bank of India (RBI), but none as acrimoniously inconclusive as the one on October 23, 2018. There were major differences of opinion between the RBI brass plus some of its nominee directors and the trio of Subhash Garg and Rajiv Kumar from the Ministry of Finance (MoF) and S Gurumurthy, a chartered accountant better known as a convenor of the Swadeshi Jagaran Manch. 

Matters worsened with Deputy Governor Viral Acharya’s AD Shroff Memorial Lecture on October 26, 2018 where he pointedly demonstrated the pitfalls of government interference in the finances and decision-making independence of central banks. The RBI governor has now called the next central board meeting on November 19 to deal with various unresolved issues. Every economic and financial commentator tensely awaits its outcome.

Make no mistake about this: The core issue is that the MoF wants to dip into the RBI’s reserves to pocket Rs 3.6 trillion — and has utilised the never-used section 7(1) of the RBI Act to make this claim. Here are some facts. From 2013-14, the RBI has been transferring its entire annual surplus of income over expenditure to the central government. These amounts are huge: Rs 500 billion in 2017-18, Rs 306.5 billion in 2016-17, more than Rs 658 billion each year in 2014-15 and 2015-16, and almost Rs 527 billion in 2013-14. The smaller transfer in 2016-17 was due to huge additional costs incurred because of demonetisation, the government’s economic idea par excellence.

Not satisfied, the MoF believes that the RBI has no reason to have Rs 10.46 trillion of reserves, and ‘under public interest’ it ought to fork out Rs 3.6 trillion to the exchequer. This year, the central government is in a fiscal hole. Cutting excise on petroleum products to dampen fuel price hikes has exacted a big toll; tax buoyancy is less than estimated; and disinvestment proceeds might fall short of the target. The government needs to demonstrate its fiscal prudence as well as to fund some extra handouts before the general election. Where better to get the funds from than the RBI’s coffers?

On this, the RBI shouldn’t budge an inch. For one, if the government can’t meet its deficit targets, so be it. It can’t march to the RBI and say, “Hand over your reserves. It’s mine.” For another, these reserves have been accumulated over the years from seigniorage income (the difference between the value of new notes printed by the RBI and the costs of printing and distribution) and interest paid by the government to the RBI on the latter’s holdings of government securities. These are kept to fight contingencies. There are many: Sudden currency fluctuations, decline in the rupee value of gold, depreciation in the value of the RBI’s holdings of government bonds, insuring deposits, extraordinary expenses and, most importantly, to ensure that the RBI has enough financial muscle as the lender of last resort. You can’t use disingenuous arguments about the reserves being greater than warranted. The red line is this: Such reserves are not for the government to pocket when its exchequer faces threat. Period.

The RBI must also stand firm on two other issues. First, there can’t be any dilution whatsoever on the Prompt Corrective Action (PCA) framework that was unveiled on April 13, 2018, which constrains the operations of 11 weak public sector banks riddled with bad loans. These are, in increasing order of feebleness, Corporation Bank, Allahabad Bank, Bank of India, Oriental Bank, United Bank, Dena Bank, Bank of Maharashtra, UCO Bank, Central Bank of India, IDBI Bank and Indian Overseas Bank. 

As on March 31, 2017, their ratio of gross non-performing loan assets (NPAs) to gross advances ranged from 11.7 per cent to 22.4 per cent. The situation is worse today. Acutely hypertensive diabetic patients must be under tight control. They can’t be given extra doses of glucose. So too these banks. They have to turn around before demanding relaxation.

The second is the RBI’s notification of February 12, 2018 on early recognition of stressed assets. Today, banks have to inform the RBI on a weekly basis which accounts have not paid their principal and interest dues in the first 30, the second 30 and the third 30 days of each quarter; myriad unsatisfactory restructuring schemes have been eliminated; instead, the stressed accounts, where so deemed, must be sent for resolution under the Insolvency and Bankruptcy Code. Defaulting companies hate such toughness. So do banks because rolling loans gather no loss. No surprise, therefore, that defaulting companies and banks have been complaining to the powers that be. Given funding needs for the 2019 elections, such complaints have become more significant.

There are a couple of issues where the RBI can accommodate the government. These relate to higher credit flows for medium and small enterprises that are genuinely suffering from the want of working capital; and easing the credit flow from banks to non-banking financial companies. But on walking off with the reserves, easing PCA and early recognition of stressed assets, there should be no ‘give’ whatsoever.

Some of these issues can be resolved if the actors learn how to quietly communicate, not gesticulate. And it will do for this government to follow a simple maxim: “Nose in, paws out”. Ask questions; critique when required; but keep your hands off the till.

The author is an economist and chairman of CERG Advisory Private Ltd