I HAD thought the typhoon had finally blown over! I meant, the RBI versus the Union finance ministry standoff. Not quite! It is showing signs of a comeback as on this Tuesday RBI Governor Urjit Patel told a parliamentary standing committee that the current levels of reserves are necessary, viewed from international volatility and from maintaining sound credit worthiness. The use of reserves, I may remind, has been one of the key bones of contention between the two economic pillars.
I thought I will take a closer look at the RBI versus the Union finance ministry standoff faceoff.
Bones of contention
Before I proceed further I will recapitulate on the backgrounders.
The Union finance ministry recently had come up with the idea of a ‘resolution corporation’ to be set up independent of the RBI in cases of banks going broke and unable to repay deposits under ‘the financial resolution and deposit insurance bill’. Fortunately, with a huge public outcry against it, the bill was cold-stored (discussed in details in these columns in December last). The ministry had proposed the establishment of an independent payments regulatory board (outside of the RBI) for digital payments in the country. The RBI management rejected these proposals outright, sensing an affront to its authority. Thirdly, the government for the first time ever recently nominated a director with strong political affiliations on the central board of RBI raising eyebrows of independent career economists in the RBI management team. I take these as potent enough pickaxes to pit the RBI against the Union finance ministry.
Now, onto the current scene. The government is in dire need of funds to meet its post-demonetisation scenario of drying-up of liquidity particularly in the MSME sector. It is also faced with serious concerns for containing fiscal deficits at 3.3 per cent of GDP as targeted. These are in spite of the Rs 2.70 lakh crore extra received on petroleum product duties throughout the year and the renegotiated gas prices and waivers of off-take penalties of another Rs 62,000 crore from Qatar, so also the incremental revenues from GST to the Centre around Rs 65,000 crore and incremental direct tax collections of around Rs 1.5 lakh crore. The targeted infrastructural projects however seem crying for funds.
Tapping into RBI reserves
So, on one side the government needed money on the other the RBI has accumulated reserves from past surpluses of about Rs 10 lakh crores. Hence the government looked to tap into these reserves. I may mention that under the RBI Act, the RBI can transfer its current year’s operating surpluses to the government. But, to partake of the accumulated reserves, the government needs to traverse the difficult path through both houses of the Parliament for an amendment. More importantly, of the Rs 10 lakh crore, around Rs 7 lakh crore are from revaluation of gold and the rupee – and these are unrealised gains for contingencies against future fluctuations. In lay terms, when the dollar appreciates the excess values of the holdings goes to the reserves and when it depreciates the reserves absorb the slide. Financial prudence requires these reserves not to be touched simply because they mitigate risks of volatility. A real-life example of this was in Israel where the Central Bank had eaten up the reserves and did not quite know what to do when the Shekel strengthened! Incidentally, we have a case on hand at the moment: in two weeks the dollar depreciated by 6 per cent against the rupee.
Secondly, the RBI had announced prompt corrective actions for weak PSU banks, tightening capital requirement norms at 12 per cent of their risk-weighted net assets. I may mention here that Basel III – the international norms for prudential lending – is 8 per cent for regular borrowers. The government wanted relaxation of RBI norms by one year to get a little more liquidity in the pipeline for MSMEs as also allowing restructuring of their stressed loans up to Rs 25 crore.
Thirdly, a word was doing the rounds that if the RBI Governor was not willing to relent, the government could invoke Section 7 of the RBI Act under which it has powers to issue directions to the RBI in consultations with the Governor. The Governor then has to seek a dignified exit.
Showdown fizzles out
Thankfully, the showdown did not take place and a much welcome truce was called: the PCAs were deferred by a year and the issues of reserves would now be referred to committees. This now frees up sums reportedly around Rs 3.7 lakh crore for MSMEs. My caution is: in the enthusiasm for promoting the well-intended ‘59-minute loans’, banks do not bypass due diligence norms in the sanctioning process.
That the matter should have come to such a pass was in itself undesirable. Viewed from our sovereign rating angles, we are at BBB (-) (lowest investment grades) in both S&P and Fitch. (China is A+). We have to be careful in our financial prudence versus populism.
Having been at the helm of finance of huge corporates myself I can say that we need growth, but with stress on distribution of wealth and opportunities under strict financial discipline. Remember also that the RBI has to exercise control on banks and financial Institutions against delinquencies on its money supply and therefore on inflation and of course on the rupee and its rates. In the past two years the RBI did not quite cover itself with glory either – counting notes for two years post-demonetisation as also for unchecked big-ticket heists in banks and financial messes of the highest orders in huge NBFCs.
Lessons learnt – the two sides must here onwards communicate much more with each other through structured interactions, through convergence of perceptions and walk the path of growth together, doing an Aldous Huxley in his ‘Doors of Perception’ where he says: “…If the Doors of Perception were cleansed everything would appear to man as it is: Infinite. For man has closed himself up, till he sees all things through narrow chinks of his cavern.”