Political concerns behind govt. step down in War with RBI for Now

The move may well be temporary and more a case of shrewd politics than common sense.

MUMBAI, NOV 20: The statement issued by the Reserve Bank of India (RBI) after a marathon board meeting on Monday evening has indicated that the government may have stepped back from its earlier stand. At least for now.

It is however likely that at the next meeting of the board, scheduled for December 14, some of the contentious issues may come back on the table.

There has been a raging battle between the government and the RBI ever since the last meeting of the RBI’s board of directors and subsequent comments by Deputy Governor Viral Acharya about the independence of the central bank at a public lecture.

The government has been reportedly insisting that the RBI part with substantial corpus of its reserves and most experts believe this will help the government plug its fiscal gaps, but may not be such a good idea from the RBI’s point of view.

Other points of friction have been a liquidity squeeze in the small and medium enterprises sector on which the government believes the RBI has been unresponsive; it also wants some of the banks on which lending restrictions were earlier imposed to be taken out of the prompt corrective action (PCA) framework.

The marathon nine-hour meeting was expected to be a stormy one, with government nominees and some other directors expected to strongly advocate the government’s line. But according to former finance minister P Chidambaram in a television discussion after the meeting ended, the government may have taken a few steps back (by not insisting on all the contentious issues) so that the impending elections in some crucial states go through smoothly; Newspapers have been flashing the Govt-CBI spat on their front pages much to the former’s discomfort.
The RBI statement mentioned that the board 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.”

Three major decisions were taken:

1) 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 and the RBI.

2) 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 Rs 25 crore, subject to such conditions as are necessary for ensuring financial stability.

3) And with regard to banks under PCA (prompt corrective action), it was decided that the matter will be examined by the Board for Financial Supervision (BFS) of RBI.

The most contentious of the three major issues discussed was the regulatory capital framework or the reserves the central bank continues to hold. The RBI has been speaking out against the government’s reported contention that it is over-capitalized, by saying that it needs healthy reserves to counter any risks that may emerge in the economy. The government feels the RBI could be sitting on excess capital of anywhere up to Rs 3.6 lakh crore.

By placing all government directives under Article 7 of RBI Act , RBI Governor, Urjit Patel, has deflected all the government pressure over him to transfer RBI reserves of Rs.3.6 lakh crores to the Board of Directors.

Now that the board of the RBI (which comprises two government nominees) has agreed to constitute an expert committee to deliberate on this contentious issue and find out what capital adequacy should be in the current scenario, any confrontation and fallout of this debate has been postponed.

YV Malegam, one of the longest serving former members on the board of the RBI, told media that capital adequacy of the RBI should be determined periodically and the decision to ask a panel to study the matter was a good one.

On getting some banks out of the PCA framework, too, the fact that the Board for Financial Supervision (BFS) has been tasked shows that the government has not unduly insisted on being a party to the decisions in this matter and that it remains with the RBI’s domain.

The RBI implemented the PCA norms at the beginning of this fiscal and currently, 11 of the 12 banks in the new framework are PSU banks. These banks face lending restrictions and some other curbs so that they eventually become stronger. Government officials had earlier alleged that neither was the government consulted before RBI framed the revised PCA norms, nor were suggestions by government representatives in subsequent meetings on relaxing lending restrictions for such banks heeded.

On the matter of easing liquidity for the small and medium businesses, the RBI seems to have bowed to the government’s wishes in a limited way and this again is a good move.

Former Finance Minister, Yashwant Sinha, has commented that the  nine-hour board meeting of the RBI hints at some financial emergency. But actually the case is merely a breakdown of communication between the government and the country’s central bank. He recommended that instead of escalating tensions the government must ensure that the demands it makes of the RBI are within the framework of the act under which the central bank functions.

(With inputs from PTI)