Two years after the government unilaterally banned over 90% of currency notes, the relations between the finance ministry and RBI have again come under a cloud. At stake among other things is RBI’s reserve money, which the Centre wants to lay its hands on.
It is not surprising that the debate on the autonomy of the RBI vis-a-vis the government has arisen on the eve of the date that marks two years of demonetisation. Months ahead of the actual announcement, erstwhile RBI governor Raghuram Rajan had told the government that the short-term costs of demonetisation would outweigh any long-term gain. Dr Rajan’s opinion was sidelined and he left the RBI. This irrational policy has not provided any gain to the economy. Rather, it has slowed down the growth rate, almost destroyed the informal sector and eroded both the credibility and the profits of the central bank. Dr Urjit Patel as the governor of RBI implemented this illogical policy succumbing to the whims of the government. He has now the task of the dealing with the aftershocks.
Dr Patel and his team have now raised objections to the government’s proposals on at least three important issues. Firstly, the government proposed to move the Payment and Settlement System outside the purview of the RBI and constitute the Payment Regulatory Board (PRB) as an independent regulator. RBI has publicly dissented with this proposal of the government and rightly so. Payment and Settlements are fundamentally linked with currency and banking sector in the economy, for which RBI is the regulator. Appointing an independent PRB will involve dual regulators and would be to the detriment of the stability of the system.
Secondly, the government had hinted that it would like the RBI to transfer the excess capital in its balance sheet to the government. Speculation is that the government wants to undertake spending in the economy eyeing the forthcoming elections. This is a strange demand which amounts to weakening the balance sheet of the RBI. An excess fund is necessary for the RBI to mitigate any potential losses in the future. As per law, the government is entitled to the profits of the RBI, but not to its surplus funds. Thirdly, the government is unhappy with the RBI for implementing strict lending norms on public sector banks which are under stress. It wants the RBI to relax those norms and provide more credit to the MSME sector in particular.
The public debate between the government and the RBI exposes not merely an institutional failure of dealing with differences. Rather, it points towards serious economic problems facing the economy. In spite of the tall claims of the government regarding high growth and employment generation, a cursory glance at the data shows that neither of these claims have much empirical basis. But with the elections approaching, the government is desperate to increase public expenditure for growth and job creation. One way of doing it is to increase spending by increasing the fiscal deficit. But the FRBM Act forbids the government from doing so. Hence, the government wants to take the surplus fund of the RBI for hiking up its spending. Such a move would be detrimental for the RBI’s operations and might lead to markets reacting adversely.
It is undoubtedly the case that there has been a credit slowdown in the economy, particularly in the industrial sector. This credit squeeze is affecting the prospects of the MSMEs, where the credit growth for micro & small enterprises has turned negative and only 1.5 per cent for medium enterprises. This has resulted in the clamour from sections of the government for an easing of lending norms for the MSME sector, which might pace up growth and jobs. But such lending within an already existing milieu of NPA (non-performing debt) problem would be obviously opposed by the RBI, as the regulator.
The structural issue however remains with profits of public sector banks witnessing a nosedive in 2017-18 as a result of provisioning for bad debts. The problem is that if the banks are not allowed to lend, there may be a further erosion in their profits. This might then be cited as logic for privatisation of public sector banks. The persisting NPA problem and the high hair cuts that are being applied during recovery of loans show that much is desired from the RBI as the regulator of the banking sector. Overall it seems that both the government as well as the RBI are unsure about how to resolve the NPA crisis as well as increase credit disbursal in the economy.
The economic problems should not however make us gloss over the severe institutional stress between the government and RBI. The appointment of known RSS functionaries within the RBI board who have very limited understanding of banking and finance has only added to the problem. Moreover, the government’s invocation of Section 7 of the RBI Act for consultation further shows the almost breakdown of communication between the two most important pillars of economic policy making in India. To conclude, the problem between the RBI and the government is a result of economic problems afflicting the economy as well as the government’s proved ineptness and high-handedness in dealing with important institutions of the country.
