Even though the meeting between the government and the RBI might have ended amicably, it remains to be fathomed whether the outcome has opened the door for accelerated national growth or unprecedented financial uncertainty.
Eighty years is a long time to maintain a status quo and guard a financial institution and the cash reserves of the nation from injudicious political interference. As is common knowledge, there has been government pressure on the RBI to accede to a range of demands, provoking RBI Deputy Governor Viral Acharya to issue a warning in October that the undermining of the central bank's independence could be "catastrophic."
On November 9, according to multiple news sources, the government had said that it was discussing an "appropriate" size of capital reserves that RBI must maintain, but denied that it was seeking a massive capital transfer. The point of contention was simply this: how much reserves should RBI keep locked in its coffers?
As NDTV said, "The people sent to the RBI board by the government want the centre to have access to surplus reserves the RBI has built up - money that could be used for the administration's populist programmes including boosts to rural wages, fuel subsidies and buying crops at a guaranteed minimum price."
Another point of contention was lending to non-banking financial companies and MSMEs because the bank wanted to be tough with the defaulters, while the government wanted the bank to lend more to these sectors in view of the difficulties they faced during demonetization and the implementation of the Goods and Services Tax (GST).
But the long wait to see who will blink first, the RBI or the government has ended because after a nine hour board meeting on November 19, the RBI agreed to set up a panel on sharing surplus reserves.
This decision does not mean that the door is open for the state, but it is a crack in the door. And just like demonetisation, it will have long term ramifications. And it will forever change, even though subtly, the equation between the RBI and the state. For now, to use a newsroom cliche, the markets and investors are also closely watching the developments.
In today's Moneycontrol podcast, we will break down this meeting that may turn out to be momentous in retrospect.
Let us begin with an NDTV quote, "The meeting of the board of the Reserve Bank of India has ended after over nine hours, amid what analysts say an atmosphere of mistrust over perceived government interference in the central bank's functioning. RBI agreed to set up a panel for sharing surplus and also to restructure loans of small businesses."
The opposition was quick to react and Congress president Rahul Gandhi tweeted and we quote: "Mr Modi and his coterie of cronies, continue to destroy every institution they can get their hands on. Today, through his puppets at the #RBIBoardMeet he will attempt to destroy the RBI. I hope Mr. Patel and his team have a spine and show him his place."
The government has maintained all along that it really has no intention to tamper with RBI's functioning but as the NDTV report says, " the opposition has alleged the NDA regime intends to plough into the precious reserves of the central bank in election season."
Any sign, says the report, that that all's not well in the RBI could mean trouble for the markets but of course, the first sign of trouble came in October when reports alluded to the government's interest in Section 7 of the Reserve Bank of India Act which empowers the centre to issue directions to the "lender of last resort" - meaning the government could take charge of policy. Last year, former RBI Governor D Subbarao said Section 7 has never been used in more than 80 years of the central bank's history.
Here goes the current set of events just to clarify where we are now.
Reuters reported that the RBI agreed on Monday to set up an expert panel to examine the economic capital framework of its workings, in a move that could prompt a rethink of what constitutes adequate capital reserves for the central bank.
The RBI issued a statement post the meeting, "The Reserve Bank of India's (RBI) Central Board met today in Mumbai and discussed the Basel regulatory capital framework, a restructuring scheme for stressed MSMEs, bank health under Prompt Corrective Action (PCA) framework and the Economic Capital Framework (ECF) of RBI. The Board decided to constitute an expert committee to examine the ECF, the membership and terms of reference of which will be jointly determined by the Government of India and the RBI.
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 ₹ 250 million, subject to such conditions as are necessary for ensuring financial stability.
The Board, while deciding to retain the CRAR at 9%, 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 March 31, 2020. With regard to banks under PCA, it was decided that the matter will be examined by the Board for Financial Supervision (BFS) of RBI."
While loans of up to Rs 25 crore may end up being restructured, the RBI also announced that it would inject Rs 8,000 crore worth of liquidity into the system through open market operations on November 22.
Subtle shifts in the economic climate
Even before the meeting could throw up a decisive set of conclusions, the rupee slipped by 9 paise to 72.02 against the US dollar in early trade on Monday, reported news agency PTI.
A dealer at a foreign bank was quoted by NDTV, "Foreign investors will wait to get some cues from today's meeting on the extent to which the central bank is autonomous, but it will be good for bond markets in the short-term if the RBI gives in to the government's demand for more liquidity."
A key protagonist
One of the strongest champions of the government's increased involvement with RBI's affairs has been S Gurumurthy. Swaminathan Gurumurthy is interestingly serving as a part-time director of RBI. He is also the editor of Tamil political weekly Thuglaq and is a chartered accountant. And the co-convenor of the Swadeshi Jagaran Manch.
One of his demands has been that RBI board concede to easier lending and capital restrictions for banks and more cash for small businesses. This is a view also supported by top finance ministry officials and is at the heart of the disagreement between the government and the central bank.
As Business Standard put it and we quote, " Locked in a power struggle over how much capital the central bank needs and how tough its lending rules should be, a trained accountant parachuted into the Reserve Bank of India’s board by the government in August may be key to whether a compromise can be found or whether the already public spat turns even uglier.
Swaminathan Gurumurthy, a chartered accountant turned-newspaper-columnist, has set the tempo by chiding the monetary authority for being too tough in its efforts to rid banks of bad debts and arguing the case for lower reserves - a step that would give the government more cash ahead of an election year."
The piece further informs that Gurumurthy, who is associated with the economic wing of Rashtriya Swayamsevak Sangh was chosen by the government to push easier access to credit for micro and medium-sized enterprises. Lending to the sector has suffered after the RBI tightened norms for state-run banks saddled with bad debts.
Gurumurthy and the government nominees Subhash Chandra Garg and Rajiv Kumar, have been vocal about bank supervision, flow of credit to industry, and easier financial conditions for India to overcome a crisis in its shadow banking sector.
Business Standard cites Mohan Guruswamy, a former finance ministry official and chairman of the Centre for Policy Alternatives in New Delhi, who has known Gurumurthy for years and we quote, "Having Gurumurthy on the RBI board has complicated the situation. He wants banks to give money to non-bank finance companies, which are already in a mess. He’s an RBI director. It’s not his grandfather’s money.” Oh well, that was personal but just goes show that emotions run high and decorum leaves the room when a contentious argument involves huge sums of money.
As various news sources have reported, previously, the RBI would usually propose new board members or the government would at least consult the governor before nominating members. This time, there has hardly been any consultation.
Of the 18 current members in the RBI board, five come from the government bureaucracy, two are finance ministry officials, and two have close links to the BJP. Four have a business background, and the other five are Urjit Patel and his four deputy governors. In August, S Gurumurthy and Satish Marathe, a former banker who was in the student wing of the BJP, were named to the RBI board. And last month, the government appointed retired bureaucrat Revathy Iyer and Sachin Chaturvedi, head of a Delhi-based think tank, while removing Nachiket Mor, who was close to RBI officials.
What lies ahead
Bloomberg reported on November 19 that India’s rupee and bonds may come under pressure as the government’s attempts to restrict RBI’s freedom will unnerve overseas investors.
The next RBI board meeting in the meanwhile has been scheduled for December 14.
The economic climate continues to be wary.
As Bloomberg put it, “Prime Minister Narendra Modi’s administration is believed to be seeking closer supervision of the Reserve Bank of India by recommending the board draft regulations allowing the establishment of panels overseeing such functions as financial stability, monetary-policy transmission and management of reserves."
The piece cites Anders Faergemann, a fund manager in London at PineBridge Investments, "Any moves by the government that would undermine the independence of the RBI would make us think twice about re-entering the Indian bond market. Strong institutions are critical for any country and to attract foreign capital the central bank will have to remain independent.”Though observers say the first meeting was amicable, whether it has opened the door for accelerated national growth or unprecedented financial uncertainty is yet to be fathomed.