The tussle between the RBI and government is not new. History has its own way of repeating things and so is the case with this acrimony between Delhi’s politicians and Mumbai’s technocrats. The two interlocutors have come face to face during Nehrunian phase resulting in quitting of Rau, the fourth governor of RBI in 1957[1]. After that scrimmage between the north block and RBI during crisis which resulted in shift of stance of RBI and transfer of profits from RBI to government[2]. Finally, the current issue of rivalry over liquidity, transfer of profits and equity and easing up of PCA norms is causing acerbic atmosphere. But as quoted by Raghuram Rajan, former RBI governor in one of the interviews –” You have to know why the other guy is doing what he is doing and ultimately at the end of the day you have to part maybe not as friends but having respect for each other’s territory. It’s when you encroach each other’s territory that it becomes problematic[3] “, the two parties should respect each other’s turf and prevent any kind of acrimony.
When Sir Benegal Rama Rao, the fourth governor of RBI, couldn’t bring the conflict between Jawaharlal Nehru and then finance minister TT Krishnamachari to an arbitration he decided to quit the post. Rau had accused TTK of “rude behaviour” over differences that began over a budget proposal. Nehru went on state that “Monetary policies must depend upon the larger policies that government pursues. RBI cannot challenge the main objectives and policies of government[4].”
But the recent NPA crisis and couple of other factors have driven the issue to yet another level with each side seeking hegemony over the financial system of the country. To begin the analysis, we would first dig deeper into the current NPA situation. As per a report the NPA in India stands at 9.85% in 2017. The only countries with similar NPA values are troubled EU nations, namely, Portugal, Italy, Ireland, Greece and Spain referred as PIIGS. India is ranked 5th highest in terms of NPA ratios with Greece, Italy, Portugal and Ireland having higher NPAs than India[5].
As evident from the above description, the NPA situation in India has worsened to a great extent and needs immediate steps to be resolved. So to deal with the similar scenario, RBI has taken various steps to regulate liquidity flow in the country. Working alongside the similar directions RBI has put 11 banks on Prompt Corrective Action ( PCA ) framework[7] . Under the PCA framework, RBI has set three risk threshold limits and precautionary measures for the same.
However, the results as obtained from this step were heterogeneous. Even though the banks saw a rise in Net Interest Income( NII ), the fall in asset quality continued. The 11 banks saw net interest incomes (NII) — the difference between interest earned and expended — rise as much as high as 114% on a year-on-year (y-o-y) basis. However, gross bad loan ratios rose 195–667 basis points (bps)[8].
Moreover, stricter liquidity norms have pressurized NBFCs in return which makes it difficult for them to get access to loans. Pleas from banks and NBFCs have caused government to ask RBI for easier norms and rules. Addressing to these pleas, RBI has taken various steps to ease up the liquidity norms for banking sectors, NBFCs and HFCs. RBI has decided to cut down SLR to 18% from current 19.5% with quarterly 25 bps reduction starting from January 2019. RBI has also done OMO purchases worth Rs. 1 trillion between September and December[10]. The recent OMO purchase of 15,000 crore was done on December 27, 2018[11].
A mixture of ‘curative’ and ‘preventive’ measures can possibly help us in finding the right solution. Two key areas, which we can focus on, are –
1. approval of specific resolution plans for 20–30 large stressed assets by a government committee
2. conversion of a portion of debt of stressed assets to equity may partly alleviate the problem
Development of corporate bond market, the idea of securitization and debt equity swaps will eventually help the government deal with the NPA crisis.
Another major issue pertaining to the same dispute is transfer of excess capital from the central bank to government. The Finance Ministry has asked the RBI to transfer a surplus of Rs 3.6 lakh crore, more than a third of the total Rs 9.59 lakh crore reserves of the central bank, to the government[12]. “We expect the proposed committee on the RBI’s economic capital framework (ECF) to identify Rs 1–3 trillion which is 0.5–1.6 per cent of GDP as excess capital,” analysts at Bank of America Merrill Lynch said in a note Monday. The brokerage report said as per its stress tests, the central bank can transfer Rs 1 trillion to the government if the transfer is limited to passing excess contingency reserve and can go up to Rs 3 trillion if the total capital is included.
However, Raghuram Rajan, former RBI governor, has a completely different story to tell. “There is no 3 lakh crore that the RBI can give the government and say do what you want with it because it gives from one hand and it sells an equivalent amount of government bonds in the market. Net net the public sector borrowing requirement does not change. The government has the same problem financing its deficit as it had before because this 3 lakh crore cannot be used.” said Raghuram Rajan in an exclusive interview by Economic Times[14]. Adding on he said “We are a country which has a BAA rating and if the country went out to borrow in international capital markets for some emergency it would have to pay at BAA rating rates. Having the RBI as a separately capitalized entity which has a AAA rating gives you a vehicle which can actually make promises in international markets that are credible.”
The two institutions must work parallel to each other and one should respect the autonomy and independence of the other. Rightful balance between the two financially important institutions would pave way for a greater macroeconomic stability of the nation.
[1] https://timesofindia.indiatimes.com/india/nehru-letter-to-rbi-may-give-modi-government-ammunition-in-urjit-row/articleshow/66503739.cms — Nehru letter to RBI may give Modi government ammunition Urijit row(TOI dated November 25, 2018)
[2] https://www.rediff.com/business/column/rbi-govt-tussles-are-not-new/20181120.html — RBI-govt tussles are not new — Rediff( Dated November 20, 2018)
[3] https://economictimes.indiatimes.com/markets/expert-view/govt-and-rbi-have-to-listen-to-each-other-and-respect-each-others-turf-raghuram-rajan/articleshow/66520329.cms
[4] https://timesofindia.indiatimes.com/india/nehru-letter-to-rbi-may-give-modi-government-ammunition-in-urjit-row/articleshow/66503739.cms — Nehru letter to RBI may give Modi government ammunition Urijit row(TOI dated November 25, 2018)
[5] https://www.moneycontrol.com/news/business/economy/india-ranks-5th-in-list-of-countries-with-highest-npa-levels-2470313.html — India ranks 5th in list of countries with highest NPA levels dated December 28, 2017
[6] Source — https://timesofindia.indiatimes.com/business/india-business/only-4-major-nations-have-higher-bad-loans-than-india/articleshow/62275553.cms
[7] https://rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=10921 — Revised Prompt Corrective Action (PCA) Framework for Banks dated April 13, 2017
[8] https://www.livemint.com/Industry/85kgwA6kjaOlqmMVwDH9rN/Banks-under-RBI-PCA-show-mixed-results.html — Banks under RBI PCA show mixed results dated October 31, 2018
[9] Source: https://www.capitaline.com
[10] https://www.business-standard.com/article/finance/rbi-may-continue-omo-purchases-at-current-pace-till-march-viral-acharya-118120600027_1.html — Business Standard — OMO purchases may go on till March: Archarya — December 6, 2018 — Advait Rao Palepu
[11] https://www.businesstoday.in/sectors/banks/rbi-announces-omo-bond-purchase-of-rs-15000-crore-on-dec-27/story/304137.html — RBI announces OMO bond purchase of Rs 15,000 crore on December 27 — December 25, 2018
[12]http://www.newindianexpress.com/business/2018/nov/06/government-tells-rbi-to-transfer-rs-36-lakh-crore-surplus-reserve-bank-refuses-to-oblige-report-1894932.html — Government tells RBI to transfer Rs 3.6 lakh crore surplus reserve, bank refuses to oblige: Report — November 6th, 2018
[13] Source : Bloomberg Quint
[14] https://economictimes.indiatimes.com/markets/expert-view/govt-and-rbi-have-to-listen-to-each-other-and-respect-each-others-turf-raghuram-rajan/articleshow/66520329.cms
