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BW Businessworld

Bones Of Contention

The RBI and the government are at loggerheads to settle on an appropriate economic capital framework for the apex bank

Photo Credit : Bloomberg

When the RBI’s deputy governor, Viral Acharya, warned a few weeks ago that the “risks of undermining the Central bank’s independence are potentially catastrophic”, it opened a Pandora’s box, causing a furore in financial circles as it brought to the fore the ongoing huge differences between the government and the RBI in the handling of several issues including the liquidity squeeze.

“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,” Viral cautioned in a speech that created a tornado in financial markets.

In the last few weeks, speculation has been rife that the government has been seeking Rs 3.5 lakh crore from the RBI to tide over “some” imbalances. The government, however, clarified that it is not seeking Rs 3.6 lakh crore or Rs 1 lakh crore as speculated, but only wants to fix the economic capital framework of the RBI.

“Lot of misinformed speculation is going around in the media. The government’s fiscal math is completely on track. There is no proposal to ask the RBI to transfer Rs 3.6 lakh or 1 lakh crore, as speculated,” Economic Affairs Secretary Subhash Chandra Garg tweeted. The proposal for the RBI that is “under discussion is to fix an appropriate economic capital framework of RBI.”

The government is at loggerheads with the RBI over the handling of the liquidity squeeze NBFCs have been faced with after the IL&FS tempest battered the markets. The government is also said to have reservations about the handling of the PCA (prompt corrective action) framework, which restricts certain banks from giving loans, while the government wants to encourage banks to do so, particularly to the MSME sector.

The government is said to have sent a few letters to the RBI under Section 7 of The Reserve Bank of India Act, which gives the government powers to issue directions to the country’s apex bank. Section 7(1) of the RBI Act says: “The Central government may, from time to time, give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.” Section 7(2) gives the government powers to entrust the running of the RBI to its Board of directors.

The RBI holds about Rs 2.32 lakh crore in contingency reserves, and about Rs 22,800 crore as asset-development fund. The Bank also holds a further Rs 6.9 lakh crore in currency and gold re-valuation reserves, according to its annual report 2017-18.

In the past few years, the RBI has been transferring a part of its surpluses to the government. Last year, it transferred Rs 50,000 crore to the government, while the year prior (2015-16), it transferred a surplus of Rs 65,876 crore.

On the crucial issue that the RBI is not doing enough to correct the liquidity crisis, the RBI cannot lend to NBFCs directly as it can lend to banks as the ‘lender of last resort.” Neither can the RBI hold stakes in the very banks that it regulates or loans money to. The RBI has also maintained that the liquidity situation in the economy is under control even as it tries to find solutions to the mounting NPA problems among PSBs.  

The government, on the other hand, is at a crossroads in trying to fix the pitfalls in the economy without hampering its fiscal position, and is said to be looking at a bigger surplus from the RBI. For FY19, the fiscal deficit has been fixed at 3.3 per cent. The government is exuding confidence, the confidence of meeting this fiscal deficit target.  

Former RBI governor Raghuram Rajan has come to the defence of the apex bank. “The RBI is something like a seat belt. As a driver, the driver being the government, it has the possibility of not putting on a seat belt, but, of course, if you do not put on your seat belt you get into an accident and the accident can be quite severe,” he told CNBC TV18 in an interview.

For now, it seems things could be decided at the RBI’s Board meeting on November 19, which will be crucial in deciding how the apex bank will move forward. Will the RBI give in to the government’s demand or will it continue to fight for its autonomy?