Any good efficient policy meant for reviving policy has to walk on two legs. It has to be both monetary and fiscal
-Dr. Rajiv Kumar, NITI Aayog
Beyond the noises surrounding; who won and who lost, lies a decision and an opportunity for the two building blocks of our nation- The North Block and The Mint Street to work together for the collective good of the economy.
On November 19, 2018, a marathon board meeting of The Reserve Bank of India was held. Aimed at settling the right balance of power between RBI and Central Government the meeting ended after over nine hours, amid an environment of mistrust and perceived Government interference in the functioning of RBI.
UNDERSTANDING THE TUSSLE
Defense turned Defiance
Considered to be a Government loyalist, recently RBI Governor Urjit Patel along with the Deputy Governor, Viral Acharya accused Central Government of interfering with the working of the Central Bank. In reaction, Union Finance Minister Arun Jaitley blamed the RBI for failing to manage the indiscriminate lending by the commercial banks between 2008 and 2014, a reason that led to NPA crisis in the nation.
There are many reasons for this battle of arguments between the two parties:
- The NPA turbulence:
Brewing at least since February, the problem first started when RBI issued a non-negotiable bad loan notification, under which it ordered to reclassify NPAs and set new norms for loan restructuring. The norm follows a 180-day phenomenon whereby after 180 days, a stressed account will be sent to a bankruptcy court for settlement.
This new norm shadowed 11 out 21 PSUs under its radar. In fact institutions like Dena Bank and Allahabad Bank also faced restrictions on its expansion because of this policy.
2. The Geetanjali Scam:
When the 14000 Crore scam came into light which led Businessmen Nirav Modi and Mehul Choksi to flee away from the nation, the Government openly criticized the Central Bank for lacking good supervision abilities and rested the entire responsibility of the PNB scam over the Governor’s shoulders.
RBI, on the other hand, sought more powers over the functioning of the Public Sector Banks to increase efficiency.
3. Desirable interest rate spree:
The desirable level of interest rate in the economy depends upon the ultimate desirable outcome. Both The Government and The RBI have a different take on the matter. While the Government wants the RBI to cut down on the interest rates in order to provide the much-needed impetus to the economy, RBI, on the other hand, raised the rates in order to prevent the falling rupee.
4. Personality conflicts:
There have been two major incidents that fueled the fire of conflict between the Government and the RBI.
i) Dismissal of Nachiket Mor
Mor was considered to be a strong critic of the government’s demand to pay higher dividends. According to RBI, Mor was removed without tending to the courtesy of informing him.
ii) Appointment of S.Gurumurthy
RSS-affiliate Swadeshi Jagran Manch’s Co-Convener, Gurumurthy was appointed as a director on the RBI Board recently. He was a bitter critic of RBI under former Governor Raghuram Rajan’s regime.
5. SECTION-7: THE RBI ACT
RBI’s autonomy is equivalent to the article of faith.
The government of India has a dual purpose to solve. Firstly, it wanted to mitigate the problems caused to small businesses due to Demonetisation and GST. Secondly, it wanted the failed Public Sector Units to be re-capitalized.
This requirement for fresh capital would take a toll on Government’s fiscal records and with a fragile budgetary arithmetic, Government directed RBI to do its bidding. However, tensions between the two parties escalated when Government issued three consecutive letters to the RBI, threatening to invoke *section 7(1) of the RBI Act.
Former RBI Governor, Dr. D.Subarao said that Section-7 has never been used in more than 80 years.
* Section 7 (1) of the Reserve Bank of India Act, 1934, says that the Union government can “from time to time give such directions to the (central) bank as it may, after consultation with the governor of the bank, considered necessary in the public interest”. Further, Section 7 (2) gives the government powers to entrust the business of RBI to its central board of directors.
6. Relaxing Basel Norms and the framework for stressed assets:
The argument so proposed by the Government was that RBI has prescribed capital norms which are tougher than most countries of the same strata. The current ratio of capital to risk assets is 9% while the government wants RBI to resort to **Basel III norms and bring it down to 8%.
Estimates suggest that this will save approximately 55000 crores in the capital with the commercial banks and NBFCs.
However, to ensure REAL strength of the Indian Balance sheets, RBI wanted to conform to the stricter capital norms.
**Basel III norms consider liquidity risks. When you are exposed to more risk, you need a larger safety buffer. The BASEL III norms account for more risk in the system than earlier. As a result, it increases banks’ minimum capital requirements.
HIGHLIGHTS OF THE RBI BOARD MEETING
The November 19th RBI meet witnessed some major reforms and compromises made by both the parties.
- Injection of 8000 Crore Liquidity on 22nd December
RBI will be buying Government bonds worth 80Bn Rupees under Open Market operations to inject liquidity in the economy.
- Expert panel
RBI will set up an expert panel to examine the economic capital framework of the central bank in order to determine the right amount of surplus to be left with RBI.
- Rework on PCA framework and Restructuring of the MSME Loans
RBI has agreed to rework on the ‘Prompt Corrective Action’ framework to address the bad loan crisis in the Indian Banking system. The Board also advised RBI to consider aggregating loans worth Rs.25 Crores to MSMEs.
- Next RBI Board Meet on 14th December
Board member Sachin Chaturvedi acknowledged that the next BI meet will take place on 14th December.
- Panel to review RBI’s capital transfer to Government:
The Board has decided to form a panel that will look into the Central Bank’s direct capital transfer to the Government. Although the Government wanted Rs 3.6 lakh crores, the RBI had refused.
The RBI Reserves Break-up is as follows:
Capital and Other Reserves– Rs 6,733 crore
Contingency Fund– Rs 2.5 lakh crore Currency
Gold Revaluation Reserves– Rs 6.71 lakh crore
The differences might not have been completely resolved, but what is of greater long-term significance is the signal- is the fundamental shift in the balance of power from mint Street to North Block. Market sentiments move in tandem with the happenings of the meeting.
Let us see how the December 14 meeting will affect the investors and market sentiments.
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