The writer is an economics and business commentator based in New Delhi. He is an economist by training and has worked in most of the leading newspapers of the country for the last 34 years. He also teaches economics and international business in MBA programmes for the last seven years and has been involved with various think-tanks in the capital.
There is an uneasy truce between North Block and Mint Steet. The union finance ministry has mulled invoking a rare Section 7 of the RBI Act – whereby “public interest and the requirements of the India economy” have to be kept in mind – in its ongoing consultations with the Reserve Bank of India. Although its statement issued on October 31 underlined that “the autonomy of the RBI is essential”, whether this mollifies RBI’s top officials is a different matter altogether.
All eyes will now be on the central bank’s board meeting on November 19 as how the government’s directions will be met. North Block’s differences with RBI stem in good part from the latter’s firm and unyielding response to dealing with debt-ridden public sector banks that account for 70 per cent of the country’s banking assets and 87 per cent of its losses. Out of the 21 PSBs, 11.are now part of the RBI’s Prompt Corrective Action regime that imposes operational and lending restrictions to nurse them back to banking health. The finance ministry has been exerting tremendous pressure on the RBI to dilute these norms that so that atleast 3 out of the 11 PSBs can resume lending. The central bank, for its part, has resisted doing so. The seeds of the PSU bad loans problem date to the mid-2000s when the India economy boomed in line with global trends. The bullish mood of the those times triggered what the Economic Survey termed “over-exuberant investments” by India Inc especially in infrastructure projects through public-private partnerships. India’s banks, led by those state-owned, financed this investment boom. The ratio of credit to GDP rose sharply from 25 per cent in 2001-02 to 52 per cent in 2016-17. Yet by 2010, many such investments stalled for various reasons including slower growth. PSBs were left holding the can.
The enormity of this problem surfaced in 2015 when the RBI asked banks to recognize bad loans and clean up their balance sheets. The provisioning for deteriorating asset quality sent these banks’ operating earnings into negative territory. Contrary to popular perception, the central bank consulted with North Block every step of the way when it announced revised PCA norms on April 13, 2017. The government was in “broad agreement” with its proposals. But in July this year, North Block has been pushing the RBI to relax this framework for weak PSBs so that they can resume lending. The government is worried that the ongoing travails of PSBs casts a troubling shadow over the India growth story. Although it registered a robust GDP expansion of 8.2 per cent in April-June 2018-19, sustaining it critically depends on more credit flows to revive investments. PSBs, for their part, cannot lend as they are burdened with a mountain of non-performing loans that were advanced in the go-go years, especially 2006 to 2008. Ahead of national elections in early 2019, it is keen to ensure that more PSB bank lending kickstarts investments by India Inc and small and medium businesses.
In contrast to the government’s electoral–driven short-termism, the RBI has taken a longer term view on dealing with crisis-ridden PSBs. Hitting out against the former’s relentless pressure to relax PCA lending norms, a deputy RBI governor, Viral Acharya, in his AD Shroff Memorial Lecture forcefully said: “Sweeping bank losses under the rug by compromising supervisory and regulatory standards can create a façade of financial stability, but inevitably causes the fragile deck of cards to fall in a heap at some point in future, likely with a greater tax payer bill and loss of potential output.”
Besides PCA norms, there have been other flashpoints between North Block and RBI this year. In April, the RBI governor sought more powers to regulate PSBs. In the current dispensation, the RBI cannot change the board of PSBs while it can do so for private sector banks. The finance ministry responded that the central bank has adequate powers to do so. In August-September, the government appointed part-time, non-official members to RBI’s board like S Gurumurthy of the Swadeshi Jagran Manch. The RBI was upset that Nachiket More was removed 2 years before his term ended. At the board meeting, Gurumuthy made a forceful pitch for relaxing PCA lending norms and Micro, Small and Medium Enterprises ‘forbearance’ that would ease the criterion for banks in recognizing loans to this segment as non-performing and accordingly step up credit flows. According to the Indian Express, it was this sort of unrelenting and persistent demand that triggered Acharya’s outburst in his AD Shroff lecture. Then there was a dissent note submitted by the RBI in October over North Block’s proposal to have a separate payments regulator bypassing the central bank.
Looking back in time, the government of the day – UPA and NDA for instance – sparred with the RBI over interest rates. While finance ministers preferred lower to higher rates to reduce costs of capital and boost economic growth, RBI governors were more hawkish on raising them to bring down inflation once and for all. This is a classic instance of “public interest and the requirements of the India economy” being perceived differently by the government and the central bank. The question of growth versus inflation is related to the differing time horizons for decision-making in North Bloc and Mint Street.
However, a big difference then and now was that such frictions were rarely aired in the public domain. This is not so today. A finance minister in the UPA regime famously declared that if the government had to walk alone to face the challenge of growth, then it would walk alone! Why is the RBI obsessed with inflation? Does it have the mandate to target only a particular rate of inflation? Not at all, as central banks have the flexibility to respond to various problems of the economy. So, if India’s growth remains uncertain, the RBI does have the mandate to boost economic expansion without worsening inflation. The big question is how will RBI respond to the threat of Section 7? Will Governor Urjit Patel put in his papers after the November 19 board meeting? It bears mention that the central bank’s autonomy is constrained unlike, say, the more independent US Federal Reserve. The finance ministry has the upper hand as it is the one that appoints the RBI governor. More consultations between RBI and North Block to arrive at a middle ground are certainly par for the course. If Governor Patel had no problem in implementing demonetisation, there is no reason why the RBI cannot respond to ensure more lending.
However, if the rift continues to widen, as is probable, there will be serious costs for the Indian economy and its international image as a favourable destination to do business. When rumours of Governor Patel putting in his papers roiled markets, the rupee was hammered down. The more dismal prospect indeed is that “governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire and come to rue the day they undermined an important regulatory institution” as Acharya warned in his speech. The problems between North Block and RBI thus cannot afford to get out of hand for the sake of the India growth story.