By Suvashree Choudhury and Manoj Kumar
MUMBAI/NEW DELHI (Reuters) - The board of the Reserve Bank of India advised it to act to support small businesses and give banks more time to step up capital norms, following weeks of pressure from Prime Minister Narendra Modi's government to spur lending ahead of elections.
After a nine-hour board meeting on Monday, the Reserve Bank of India said its board also decided to form an expert committee to look into whether RBI reserves are adequate, in light of a push from New Delhi for access to surplus reserves built up by the central bank.
"Overall it appears some of the government's concerns have been addressed within the parameters of the RBI's existing regulatory framework," said A Prasanna, chief economist at ICICI Securities Primary Dealership Ltd.
The Modi government is concerned that low crop prices and difficulties small businesses face in borrowing may dent its prospects in numerous state elections over coming weeks, and a nationwide election due by May next year.
Top government officials and one independent director have pressed the RBI to ease lending and capital rules for banks, provide more liquidity to the shadow banking sector, support lending to small businesses and let the government use more of the RBI's surplus reserves to boost the economy.
Unhappy about such pressure, last month RBI Deputy Governor Viral Acharya warned that undermining central bank independence could be "catastrophic". That triggered a public spat between the two sides and tension in the run-up to Monday's board meet.
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The RBI board comprises representatives of the RBI, the government and some independent directors nominated by the government. Typically RBI board meetings are staid affairs, but markets were closely focused on Monday's meeting in light of the public spat.
However the meeting itself was cordial, two sources who attended it told Reuters. "The meeting happened in a very cordial environment. Most of the issues were resolved in an amicable manner," one board member told Reuters.
"A panel will be formed to work out a framework to determine the reserves requirements of the RBI, and transfer surplus funds to the government," the board member added.
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The second source said the RBI accepted suggestions from board members to ease stressed asset classification rules for loans of up to 250 million Indian rupees ($3.49 million) to small and medium enterprises (SMEs) to support this segment, a key contributor to economic growth.
In a statement, the RBI said the board had advised it to consider a restructuring scheme for small borrowers but it didn't specify whether it had agreed or not.
Small businesses, a key voting bloc for Modi, were hit badly after an abrupt ban on high value notes in late 2016 and the subsequent implementation of a new goods and services tax (GST).
"The RBI has agreed to give a helping hand to the SMEs by allowing banks to restructure the stressed assets in this segment given that these companies were the worst hit due to demonetisation and GST," said the second source.
The RBI also agreed to extend a deadline for lenders to further lift capital conservation buffers, by one year to March 31, 2020, giving banks additional room to lend.
Indian banks have turned cautious with lending decisions after a surge in their bad debt to $150 billion. That caution is now constraining the economic recovery - industrial output growth fell to a four-month low of 4.5 percent in September.
The other two contentious issues relating to easing curbs on some banks who are under the so-called prompt corrective action (PCA) plan due to a rise in bad debt and low capital, and the one related to sharing more funds from RBI reserves, were kicked down the road to be discussed later by separate committees.
The RBI said the PCA matter would be examined by the Board for Financial Supervision of the RBI, while the government and the central bank would jointly decide on the members of a panel that would examine the reserves issue.
Investors were on watch throughout Monday for any signs of escalating tension between the central bank and government officials, but few were expecting fireworks as both sides have tried to tamp down fears of a more serious fall-out.
"Markets will be happy that this event is out of the way. In my 25 years of experience in the markets, I haven't seen such an ugly public fight between the RBI and the government," said the chief dealer at a private bank. "The uncertainty is out of the way and that's a relief for us."
India's 10-year benchmark bond yield ended at 7.79 percent compared with 7.82 on Friday, while the rupee was at 71.66 per dollar versus 71.92 on Friday. The broader NSE stock index <.NSEI> was up 0.76 percent.
"The relaxation in capital rules and SME support will make banks more flexible in the loan market, which is good news for the banking sector and the economy," said the chief dealer. "I also expect the RBI to keep liquidity conditions good given they are now trying to help revive credit growth which will be good for debt markets."
($1 = 71.6050 Indian rupees)
(Additional reporting by Neha Dasgupta; Editing by Simon Cameron-Moore and Euan Rocha)