RBI board meet today: India can't afford a warring central bank and government; time for clarity
The RBI Board meeting is very important as it will set the ideology in place that will guide the central bank in future
The Reserve Bank of India (RBI) Board meeting to be held on the 19 November is going to be a landmark one based on all the speculation that has been generated in the market. Such board meetings have always been considered to be internal affairs and never evinced any public interest.
The strong difference of opinion between the central bank and the government has toned down in decibel in the last few days. The reason could be that a possible resolution will take place through the official channel which is the Board of Directors. With new members on the honourable board, these issues would probably be taken up for discussion and a decision reached. This will provide guidance on the shape of things to come.
Let us look at some of the pressing issues. First is the one on transfer of government reserves. There has been no official demand made though innuendos have been sent thorough proxy means. The issue is interesting in terms of how it will play out. Let us assume that for argument sake the reserves of the RBI have to be brought down to keep it on par with what happens in other central banks.
This can mean one of the two things. The first is that the balance sheet has to be shrunk by lowering the liabilities. This will imply also that the assets have to come down by a similar amount to tally the balance sheet. If this has to be done then the corresponding assets, which is either FOREX or government securities or both, held have to be sold.
The reserves which are created are notional because when FOREX reserves are at say $400 billion and exchange rate Rs 65, the rupee value would be Rs 26 lakh crore. Now if the dollar becomes Rs 70 then the value goes up by Rs 2 lakh crore which goes into reserves. It is notional in the sense that the reserves have come in from outside and is not real.
If the reserves have to come down, then the dollars have to be sold which is not practical. If securities are sold instead then it will create an upheaval in the market and go against the OMO principle where the RBI is providing liquidity as it will be taking our money form the system.
The other option is to retain the size of the balance sheet but lower the reserves by monetising the same which tantamount to increasing currency, a liability, that can be given to the government. This too is jarring as it would mean monetisation of the reserves and has implications for money supply and hence monetary policy.
This would serve the purpose, however, of a suggestion from the other side that there should be no restraint on the fiscal deficit and the additional deficit should be monetised by the RBI which is not allowed today when the private placement was done away with more than a decade back. Therefore, it would be interesting to see which route is suggested for reducing the reserves of the RBI.
Another issue which will be tracked is maintenance of high capital adequacy ratio norm. Nine percent may be too conservative but has seen the system through difficult times. One reason why banks have not failed is due to strict adherence to this norm which also has led to the prompt corrective action (PCA) action when capital was not forthcoming to public sector banks (PSBs) from the government amid mounting losses.
Lowering the norm to 8 percent for example runs the risk of bringing in laxity in running business and ideally should not be allowed. But the board can take a call on this one too which will give an idea of the sustainability of the system in the coming years. This is something like saying that instead of 40 percent pass mark, the RBI has made 50 percent the benchmark to get better quality of the banking system. Now we can go back to the 40 percent mark. This leads to the PCA relaxation.
With non-performing asset (NPA) ratio of above 20 percent for these banks, can they be allowed to lend more? This can come in the way of future asset quality and capital pressures too. A solution could be to gradually make some allowances as progress is made on a pre-defined scale for these banks. Will this be the solution or not would be answered in the meeting.
There has been some critique on the one-day default and the Insolvency and Bankruptcy Code (IBC) applying after 180 days. This has affected the power sector in particular for which a special dispensation has been argued for.
The Board will have to take a call on whether it will dilute the stance which will open the doors for other sectors too also make a similar demand as no company wants to have its assets sold in the market. This will raise a contradiction to the policy enunciated by the government which brought in the IBC with much enthusiasm as it will dilute the entire process. Any compromise will mean weakening the structure carefully crafted by the government to attack this problem.
A similar conundrum holds for lending more to small and medium enterprises (SMEs). The government has done its bit by announcing subvention on interest besides other measures to help the sector. While emotions runs high on this sector given its importance, will the RBI Board be willing to relax norms on NPA or push for more lending to this sector. This is important because we did the same for the infra sector a decade back and are not able to find a solution even through the IBC as the representation of the power sector shows that the efficacy has gotten diluted.
Will it be that someday down the line, the SME NPA issue surfaces and the system blames the RBI for allowing it to bloom just as the central bank has faced this question of delaying the NPA recognition process by allowing for restructured assets mode of covering up for NPAs?
As can be seen, all the issues being taken up are interlinked and the important call to be taken is whether we take the risk of the entire cycle of NPAs playing out by doing something which happened earlier without a design?
Therefore, the meeting will be very important as it will set the ideology in place that will guide the central bank in future. This has to be cast in stone and mandated just like the MPC was mandated by legislation to target only inflation so that contradictions do not arise in future when things do not work out. Regimes and members may change over the years, but the institutional position has to be clearly defined to avoid the tyranny of ambiguity in future.
(The writer is Chief Economist, CARE Ratings; and author of Economics of India: How to fool all people for all times)