At the end of the nine-hour-long board meet of the Reserve Bank of India (RBI) on Monday, which was set in the backdrop of a bitter public spat between the central bank and the Narendra Modi government, the latter had a clear victory on a majority of the contentious issues.
The RBI has been largely pushed to agree to the government line with respect to most of its demands. The only positive takeaway for the central bank was that it got to draft a press release that made the whole affair look like a truce. It was not. To understand this, let’s look closer at the RBI statement.
Demand for transfer of RBI reserves to government: The RBI had for long fought tooth and nail against the transfer of a sizeable chunk of its reserves to the government. At the meeting, the RBI agreed to set up an expert committee to examine the ECF (Economic Capital Framework), the membership and terms of reference of which will be jointly determined by the Government of India and the RBI. The formation of this panel itself is a big deal for the government. It is now one step closer to what it ultimately wanted.
The government desperately needs RBI reserves because its fiscal situation is very week. Despite Union Finance Minister Arun Jaitley’s confidence on achieving the 3.3 percent deficit target, top bureaucrats in Delhi privately speak of a developing fiscal crisis that could worsen post-December if global crude prices don’t ease significantly.
Remember, the board (which consists of Patel and all his four deputies) has agreed to form a panel on ECF after Viral Acharya, publicly spoke of the perils of the government raiding RBI’s reserves and the need for better sense to prevail.
Many RBI veterans, too, had cautioned the government against dipping its hands into RBI reserves that are essentially meant to be a cushion should the economy plunge into a full-blown crisis. But, ultimately, the RBI has in-principle agreed to this demand.
It is fairly certain that the government will find a way to eventually get part of the RBI reserves. The only thing remaining is to watch where this money will be deployed. The chances are that this fund will be used to bridge the deficit gap and fill the bottomless pits of badly-governed public sector banks. Thus, on the issue of capital transfer, government wins the round.
Relaxing the punitive measures on weak, NPA-ridden banks: Secondly, the RBI has agreed to consider easing the prompt corrective action (PCA) on close to a dozen public sector banks that are neck-deep in bad loans and are clear examples of how badly run are the banking institutions in the country.
“With regard to banks under PCA, it was decided that the matter will be examined by the Board for Financial Supervision (BFS) of RBI,” the RBI statement said. Now, remember, these entities were downgraded to the PCA category for a good reason. This was done after the central bank was convinced that the financial mess in these banks was too severe to let them operate freely like healthy banks. Without a doubt, this action was part of the overall bad loan clean-up process initiated by the central bank in 2015. Diluting the PCA on these near-sick banks would mean undoing part of the work the RBI has done so far as far as NPA clean-up goes. But, that the central bank has agreed to relook at this action speaks volumes of who won round one.
MSME loan restructuring: Restructuring the stressed standard assets of micro, small and medium enterprises (MSEMEs) was another demand from some quarters of the government in an election year and this was publicly pitched for by the likes of S Gurumurthy as a key demand from the RBI.
The RBI statement says, “The Board also advised that the RBI should consider a scheme for restructuring of stressed standard assets of MSME borrowers with aggregate credit facilities of up to Rs 25 crore, subject to such conditions as are necessary for ensuring financial stability.”
The RBI top brass was against the idea of large-scale loan restructuring for small and medium enterprises (SMEs) because banks have already burnt their fingers in this segment. A substantial chunk of existing non-performing assets (NPAs) are from SMEs and even smaller firms which got severely hit during the demonetisation-induced cash crunch and GST rollout.
Basel III capital requirement: The RBI Board also agreed to extend the transition period for implementing the last tranche of 0.625 percent under the Capital Conservation Buffer (CCB) by one year, i.e., up to 31 March, 2020 while retaining the CRAR at 9 percent. This, too, will ease the burden on the government which is the majority owner in state-run banks that dominates 70 percent of the assets in the banking sector and will have to infuse large amount of capital in these banks.
It is learnt that the most contentious issue of government tightening its grip on the central bank by equipping the board to exercise greater control over the RBI didn’t even come up at Monday’s meeting. Probably, this will be discussed at the next board meeting. The assurance that the RBI will continue to take measures to ease liquidity in the banking system is no surprise because RBI has been doing it anyway through multiple Open Market Operations (OMOs).
The good news is that the speculation on Patel’s resignation remained just a speculation which is a big comfort for the financial markets. Both the government and RBI representatives did well by not escalating the problem to the point of pushing the governor to resign in protest. It would have sent a bad signal to the financial markets and foreigners looking at the Indian economy.
But, one important question remains: If the RBI was in agreement with the government on most of the contentious issues, why did it feel the need to go in for a public display of outrage and why did the government feel the necessity to flash the Section 7 card sparking unnecessary confusion in the financial markets?
Going ahead, it will augur well for the economy if both the government and the RBI conduct dialogue in a manner that generates confidence in the public at a time when the economy is still struggling to regain its mojo. Public spats won’t help. To sum up, Monday’s RBI board meeting can hardly be seen as a clash between the two sides. Rather, it was an event when the RBI got a reminder that the government is the ultimate authority and was forced to act accordingly. Round one clearly goes to the government.
Updated Date: Nov 20, 2018 17:52 PM