Urjit Patel deploys ultimate weapon in battle for RBI's autonomy and credibility; puts Modi govt in tough spot

Resignation is the ultimate weapon in the arsenal of any top technocrat. Reserve Bank of India (RBI) governor Urjit Patel has used it and, certainly, for a compelling reason. This wasn’t entirely unexpected though. Just two days earlier, while attending the post-monetary policy presser, Patel avoided direct questions on RBI’s differences with the government. Not once, but twice. That made it abundantly clear that the so-called truce between the RBI and the Narendra Modi government was a non-existent one; that things hadn’t passed the crucial tipping point just yet. The abrupt resignation of Patel confirms that suspicion and leaves India’s financial system up for a rude shock. The first indication of this will come when the stock markets open on Tuesday, which also happens to be the day when five states will count votes for Assembly elections. With Patel resigning citing “personal reasons”, there is a fair amount of uncertainty surrounding what’s going to happen next in the RBI-government battle. Although Patel’s statement didn’t point to the RBI-government tussle, when one reads between the lines, the actual reason for his resignation can be anything but what Patel cited in the 88-word statement. Notably, while Patel thanked the his colleagues and the RBI directors, he failed to acknowledge any ministries or the government, for that matter. Since the RBI governor’s post can’t be left vacant, one of the deputy governors will have to take over temporarily. [caption id=“attachment_3938005” align=“alignleft” width=“380”] File image of RBI Governor Urjit Patel. AFP[/caption] Although the controversy regarding Section 7 was the most talked-about issue in this context, of late, it wouldn’t be correct to attribute one single reason for Patel’s resignation. There were multiple points of discord between the government and the RBI for a while now even though things came to a collision course after Deputy Governor Viral Acharya’s public outburst. There has been an ongoing tug of war between the two constitutional entities with respect to the government’s demand for a substantial chunk of RBI’s cash reserves. The RBI wasn’t happy when the government pitched for dilution in prompt corrective action (PCA) imposed on 11 State-run banks and pushed for special provisions for MSMEs lending. Many of these issues came up for debate in the last RBI board meeting on 19 November. But the crucial issue of RBI’s governance, by a way of a board-monitored mechanism, is yet to come up for discussion. That may happen in the next board meet. Following the 19 November board meet, it was crystal clear that the RBI governor had to give in to most of the demands made by the government. Round One clearly went to the government and Patel was shown his place by government nominees. Big jolt to government But by resigning abruptly, almost nine months before his tenure came to an end, Patel has handed a major jolt to the Modi government in the power struggle. Patel has shown he is his own boss. As this writer has been saying repeatedly, when it comes to matters in the financial markets and economy, the Central bank’s words carry much more significance when compared to the political leadership. The RBI is the guardian of financial stability in the economy. The governor’s resignation will be greeted by financial markets with fear and uncertainty. By using his ultimate weapon, Patel has clearly passed the message to the Modi government and the financial markets that Central bank is facing a serious and unresolved threat to its autonomy, clearly putting the government in a questionable position. Patel fought this fight hard and was left with no choice but to use his ultimate weapon. Following Patel’s resignation, the government has been on damage control mode. Both Modi and Union Finance Minister Arun Jaitley have played down the development, praising Patel’s work and his contribution to the economy as if it was a normal resignation. But, no amount of explanation from the government will suffice when it comes to explaining the abrupt nature of Patel’s resignation. That explains the shock in the commentary from experts on the governor’s resignation including from people like YH Malegam, the RBI’s longest serving member on the central board and former RBI governor Raghuram Rajan. The RBI governor’s resignation will be watched closely by the global rating agencies and investors and will not augur well for Indian economy. Investors will question the Central bank’s state of affairs and a panicked reaction in the financial markets is most certain the days ahead.

At the 19 November board meeting, there were clear signs of the RBI being forced to agree to government demands. After opposing it tooth and nail, the RBI finally 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 weak since it is facing a cash shortage when it comes to bridging the widening deficits and infusing capital in State-run banks. If global crude prices don’t ease significantly, things could turn for the worse. Further, the RBI had to also agree 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 the banking institutions in the country are. “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. 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 reexamine this action speaks volumes of who won Round One. Patel’s resignation is too critical an issue for the government to take lightly. It’ll have to urgently prepare a plan to address the Central bank’s concerns that the government is encroaching onto its turf, creating problems in the RBI’s functioning. Just six months ahead of the 2019 Lok Sabha election, the Modi government seems to have reached the worst phase of its relations with the Central bank. The government will have to do everything at its disposal urgently to ensure the world that RBI’s credibility and independence is not sacrificed in Asia’s third largest economy. In the battle for RBI’s autonomy, the governor has sacrificed his job and irreversibly escalated the fight. Round Two has gone to the RBI.