Barely a flutter has been seen in the financial markets after a few unusually worrisome days peppered with anxiety over the manner in which RBI governor Urjit Patel huffed out of his Mint Street chair, overlapping the astonishing poll verdict when the Bharatiya Janata Party lost its mojo in three prime states.
The market response to both these ‘extraordinary’ events has been resilience: “taking all events in its stride”, “absorbing and reflecting all conditions”, a remarkably sombre stance, sans the usual stress that dogs such events. The rupee has held ground at Rs 72 to the dollar, bond yields on the 10-year G-sec have eased to 7.41 per cent, while the stock markets, post-verdict, have leaped more than 1,000 points.
And who would have thought that Patel, once known as a Modi confidant, would quit in a huff, with rumours rife that the government was trying to encircle and compress the RBI turf? Slammed “for being a silent spectator” to demonetisation, Patel has departed with his head held high. He was hailed for fighting to protect the RBI’s institutional autonomy. In the last few months, pressures from the finance ministry on various fronts compelled Patel to take the unprecedented step. Ever since liberalisation, no governor has quit prior to completion of his term.
Patel’s jaw-dropper departure was succeeded by the affable and unsurprising Shaktikanta Das, the RBI’s 25th governor, who had as economic affairs secretary held daily press conferences during demonetisation, someone who enjoys the confidence of Union Finance Minister Arun Jaitley. Ears are now to the ground on how he juggles the rod of greater government control (read, Modi and Jaitley) or rolls the ball of autonomy ahead.
It appears that the financial markets have brushed aside the contentious divisions between the RBI and the government over issues such as the PCA and dividend payouts and chosen to drive on. The incoming governor, Das, has conveyed that matters would be resolved amicably. The hope is that all the deep divisiveness that threatened to steamroll the larger economic drive may now be kept on the back-burner.
Government-RBI rifts are surely not new to this part of the world. The spat between then governor D. Subbarao and former finance minister P. Chidambaram is common lore. Subarrao alleged in a book that Chidambaram had tried to pressure the central bank to cut interest rates at a time of high inflation and that the finance minister denied extension to Subarrao’s deputies; even his own extension was due to the intervention of then prime minister Manmohan Singh. Spats had also ensued between former finance minister Yashwant Sinha and then governor Bimal Jalan in the early 2000s.
But since the 1960s, no RBI governor had ever quit. Back in 1957, then RBI governor Benegal Rama Rau stepped down after the Cabinet backed the then finance minister T.T. Krishnamachary. The spat then too centered on the RBI’s ‘restrictive’ practices versus the government’s ‘expansive’ position.
It is hard, therefore, to imagine that there could be frictionless working between the government and the RBI, particularly when the objectives of both are always at loggerheads. The government will persist in seeking ways and means to boost credit supply and growth in the economy while the RBI’s prime mandate is inflation control. Both of these sometimes don’t go hand in hand.
Perhaps a period of turmoil, though, is necessary if only to re-focus the government and institutions on the task at hand, and the roiling of the governorship has essentially been about the issue of the RBI’s regulatory autonomy.
But it was Patel’s resignation that reverberated across the financial world. Raghuram Rajan, former RBI governor, said to a news channel: “I think this is something all Indians should be concerned about because strength of our institution is really important both for growth and sustainable growth in equity and the economy.”
Even former PM Singh expressed his anguish at the manner in which the RBI was being cajoled. “Building institutions takes a long time and effort, but they can be destroyed in a whimper. It is institutions such as the RBI, among many others, that have served as the edifice of our great nation’s progress since independence. It will be foolhardy to diminish these institutions for short-term political gains,” Singh said.
A reticent governor
For his part, Patel tried his best to keep the government’s interference in the policy agenda at a minimum. He got matters going with the implementation of the Monetary Policy Committee. He spoke about the issues facing the RBI’s agenda in various conferences, and in the policy meetings.
But, in the end, Patel had no option but to call it quits. Nobody really knows the real ‘trigger’ for the resignation, which could perhaps be the subject of a book one day. But, since he still had around nine months’ tenure left speaks volumes that perhaps he was uncomfortable with the government’s high-handedness.
When he first began his tenure, Patel was known as a Modi confidant who would kowtow to the diktats of the central government. No sooner did he take charge on September 4, 2016, he had to oversee one of the largest logistical and financial challenges in Indian history —demonetisation. On November 8, currency notes worth Rs 15.44 trillion were in circulation, as per the finance ministry. The latest RBI Annual Report says 98.96 per cent of the invalidated currency notes of Rs 500 and Rs 1000 denominations were returned. Not only was the RBI unprepared, the replacement proved to be a gargantuan task due to a shortage of new currency notes.
Run up to the resignation
Post-demonetisation, Patel seemed to retreat into a self-imposed sabbatical from conferences. The RBI further curtailed access of some senior journalists from the customary monetary-policy press conferences. Also, he spoke very little at public forums.
Not long after, though, another major crisis in the form of the Nirav Modi scam perhaps first seeded the chords of discontent between the government and the RBI. Nirav Modi fled, leaving the Punjab National Bank with an over Rs 5,000-crore void. On his part, in a powerful speech, Patel pointed out that various legal constraints make it difficult for the banking regulator to discipline government-owned banks. But finance ministry officials retorted that the RBI has enough powers over public sector banks.
The dung hit the fan when the IL&FS crisis crumbled financial markets. The beleaguered institution, with over Rs 90,000 crore in deposits defaulted on repayments, sparking off a crisis of confidence in the Indian debt markets. Bond markets recoiled at the spectre of a Lehman-like crisis, but the RBI did not open any special liquidity window for the NBFCs. The RBI is a lender of last resort to banks, and so can only ask banks to buy back NBFC paper, and relaxed some norms on this front, which the banks did.
The RBI, on its part, maintains the stance that it would prefer to have system-wide liquidity rather than a special window for NBFCs or for select NBFCs. But the government wants the RBI to do more than just that because the latter roughly accounts for more than 25 per cent of loans in the economy, and is now a major catalyst of economic development.
For the government, the RBI’s handling of the NBFC situation was too little. Miffed by poor liquidity, the government started to push the RBI on many matters. It wanted the RBI to relax the PCA (prompt corrective action) framework. Under Patel, the framework had been further tightened; 12 banks (11 government-owned, one private) were under the PCA, not permitted to take deposits or make loans.
The economic constraints
The government views this as hampering liquidity flows to sectors that need it most, and wants the RBI to relax some of the criteria so that more banks can make loans. The RBI, on its part, maintains there is enough liquidity in the system, and no system-wide liquidity laxity.
Another important bone of contention is the amount of reserves that the apex bank needs to hold. In India, the central bank holds over 25 per cent in reserves, while the authorities claim that it is prudent to hold about 14-15 per cent, as per global standards. This would release about Rs 3-4 trillion, which could then be transferred to the government. For Patel, it seems this was the final straw, and he chose to hang up his boots rather than ‘compromise’ RBI’s autonomy.
The question of autonomy
What has been brought to the fore in recent days has been the key issue of whether the RBI’s autonomy will be maintained. If the government keeps pushing for its way by wanting to ‘relax’ many issues, the issue of the RBI’s autonomy will become more complicated. While all sorts of compromises and middle-ground could go some way in mitigating this stand-off, advocates of a freer RBI are adamant that if we wish to guarantee freedom to institutions, the most significant one that requires this freedom is the RBI. Hence it would be important to keep the RBI at arm’s length from the government’s policy measures.
On his part, Shaktikanta has lost no time in assuaging the financial markets’ major worry regarding the question of the RBI’s autonomy. At a press conference on his first day on the job, he said he would do everything to ensure the autonomy of the RBI.
“Every institution has to maintain its professional autonomy; at the same time every institution must also adhere to principles of accountability. We will have stakeholder consultations. We will have consultations with everybody. The government is not just a stakeholder. The government of the day runs the policy decision; so there has to be a free, fair, objective and very frank discussion with the government and the RBI. I would like to believe that all issues can be resolved through discussions. I will uphold the autonomy and integrity and credibility of the RBI as an institution,” averred Das at the conference.
An independent and autonomous RBI might still adopt a different tack, one that treads middle-ground. One might strive for recognition of the fact that there is a need to boost overall systemic lending to address some of the lack-of-credit issues plaguing important sectors of the economy such as SMEs. If there’s confidence that the final say in the matter is of the policy-makers at the RBI and not the government, and that adequate safeguards have been put in place in order to implement any new rules that could be formed, why then prohibit new developmental rules from turning into reality?
The finance minister has exuded confidence in the new governor. “Shaktikanta Das has been a very senior and experienced civil servant. He spent almost his entire career in the management of finances and economy of the country. I think he has the right credentials, he has been extremely professional and he has worked under various governments,” he averred.
Overall, the government’s position in some of these matters such as the RBI’s reserves, the liquidity situation and interest rates has to be neutral, and not seen as too much interference in what should be the day-to-day functioning of the RBI.
Afterall, the good showing in the markets, such as the strong rebound in stock markets and a stable rupee and lower bond yields may not last long. Ultimately, in trying to force its views on the RBI, the government may squander some of the advantages it now enjoys and that it wants to protect, ie, lower interest rates and strong capital markets.
Das’ challenges
It would be interesting to see how Das, a staunch defender of demonetisation, handles the government’s increasing demand for more cash, and allows weak banks reprieve from prompt corrective action. So far the RBI has resisted a special liquidity line for the non-banking financial sector, besides a protracted default norm, especially for power sector loans.
The prime demand is that the RBI soften its hawkish stance regarding interest rates, especially now that it expects inflation to fall below its targeted 4 per cent or hold within that vicinity in the year ahead. All eyes will be peeled on the tussle for the RBI’s autonomy.
THE TUSSLE FACING DAS
Loosen the PCA Framework
Under Urjit Patel more banks fell under the PCA (Prompt Corrective Action) framework, now compassing 12 government-controlled banks and a private one. Under the PCA, banks are not allowed to accept deposits, nor make loans. The government wants the RBI to loosen these norms. A Board for Financial Supervision has been constituted and assigned the task of reviewing this.
Re-examine the Economic Capital Framework
The government is of the view that the RBI ought to do more with its reserves of more than Rs 3-4 trillion. The RBI has constituted an expert committee to look into the Economic Capital Framework and address the issue of how large reserves need be. It has every year been distributing its surplus as dividends to the government.
Re-jig the new default norms
In February 2018, the RBI came out with a circular tightening the default norms for NPA recognition. The new rules say banks can start a recovery process if a company delays repayment of its loans immediately beyond 90 days. The government pitched for relaxing these norms, at least for the power sector.
Lower interest rates
As is always the perception, the government reckons that RBI has room to lower interest rates in the economy to spur credit growth (since inflation is now under control and below the RBI's target). In the recent past, however, the RBI has maintained, and even tightened, interest rates.
Create a liquidity line for NBFCs
After the IL&FS crisis, a string of NBFCs faced issues in borrowing from the capital market. On its part, while the RBI has a direct window to banks, the call has been to open a liquidity line for NBFCs faced with such issues. The RBI has maintained that sufficient liquidity is available to NBFCs, while marginally allowing banks to lend more to them.