It is ceasefire, not a truce between RBI and govt2 min read . Updated: 21 Nov 2018, 09:06 AM IST
Given all the acrimony in the past few weeks, it's understandable why the markets are relieved.
Markets are considerably relieved that the unhealthy spat between the Reserve Bank of India (RBI) and the government has been diffused after a nine-hour board meet on Monday. The Indian rupee rose and bonds gained, an indication that the absence of a raid on the central bank’s balance sheet was welcomed. The government got its demands of forbearance to small businesses and the RBI, by and large, stuck to its capital goals laid out by Basel for banks.
What was feared to end in a possible exit of the RBI Governor Urjit Patel concluded in a pithy 175-word statement from the central bank suggesting a give and take agreement. Given all the acrimony in the past few weeks, it’s understandable why the markets are relieved.
But there were issues on which the two couldn’t agree, and have decided to take the help of a committee.
And herein lies the first problem for markets. A committee based approach is a classic case of buying time with no guarantee that the solution would appease all stakeholders. This is the biggest uncertainty that hangs. The composition of the committee, its points of references and the potential to influence members is something that should not be ignored. Not to mention the lengthy periods of time a committee takes to arrive at a conclusion.
The two key issues of the RBI’s balance sheet and the rules of prompt corrective action (PCA) for banks are now the prerogative of a committee.
Shares of state-owned banks fell marginally on Tuesday in the absence of a clear solution. Even if the RBI gives leeway to PCA banks on lending, there is not enough capital for growth with these lenders.
That brings the issue back to the government’s lap in the form of much needed capital infusion, precisely the event that the centre was wanting to avoid.
The Board for Financial Supervision, essentially a policymaking body that consists of technical experts and other board members including those from the RBI, will look into possible changes in PCA rules. Meanwhile, the central bank will be back to offering forbearance to a section of borrowers, in order to avoid a credit crunch. Micro, small and medium enterprises have had a high bad loan ratio and any forbearance should be carefully crafted. History suggests that banks tend to abuse forbearance eventually.
That leaves us with the central bank’s balance sheet issue. One hopes that the committee has enough intellectual capital to arrive at the optimum level of capital without compromising on the RBI’s strength.
But it would be folly to think that the relationship between the central bank and the government is back to being cordial. It has at best gone into a moratorium of peace until the next board meeting in December.