The government cannot treat RBI like its pet (demonetisation) poodle, and in turn, the RBI cannot do away with its evolving accountability in a political framework
The incumbent National Democratic Alliance (NDA) government has distinguished itself by undermining institutions, indulging in an ‘appointocracy’ and creating an atmosphere of governmental interference in major institutions. On the face of it, the recent spat between the Reserve Bank of India (RBI) and the Union ministry of finance is another instance of this phenomenon.
Dig deeper and you will find that there is more to it. One thread is that of an encrusted RBI bureaucracy that is resistant to change. Another thread is the political economy attempting to exert its influence. Beyond these negative threads, both sides have a point and the only way to work through them is to discuss them threadbare and reach a consultative consensus.
The recent belligerent impasse between RBI and the government arises from an ill-timed and ill-advised speech by RBI deputy governor Viral Acharya. The speech followed some unnecessarily tough posturing from the government, threatening to invoke the dreaded Section 7 of the RBI Act. Section 7 grants power to the government to “give such directions to the RBI as it may, after consultation with the governor of the Bank, considered necessary in the public interest". The government is said to have sent three such directives to the RBI for consultation on issues including relaxation under prompt corrective action (PCA) norms, and a reduction in the severity of the 12 February RBI circular on defaulters.
Both sides have used strong language, with the economic affairs secretary gloating on social media about market response to the quarrel. A public spat between the RBI and the government played out in the press and social media in juvenile language is sure to incur the “wrath of the markets" sooner rather than later.
Wisdom should prevail on both sides beginning with the next meeting on 19 November. Much good can come from it, but that can only happen if there is constructive dialogue about the alternatives. The government cannot treat the RBI like its pet (demonetisation) poodle, and in turn, the RBI cannot do away with its evolving accountability in a political framework. Here are some suggestions.
Use a professional facilitator for the meeting(s): Before discussing content, both sides must agree to civil debate and must remain open to be persuaded on content. A good start would be to list objectives so that solutions can be geared toward a common understanding. If the government acts like a bully and the RBI in turn like a dog in the manger, then the situation will progressively worsen. Content is important, but tone and conduct of the meeting are even more important.
Use of reserves: The RBI believes it is protecting hard-earned reserves from politicians who are likely to fritter it away. The elected government believes that it represents the public interest and no unelected technocracy should usurp that function. The government is after all the 100% shareholder, and the central bank’s rating is clearly bounded by the sovereign rating Both have a point. The best way to bridge the two is to organize a conditional release of reserves (not including unrealized gains). One condition could be that it should only be used to recapitalize banks. Another could be a predesigned advance payment of annual dividend. Yet another could be a reserve-for-share swap where the government gives the RBI shares in non-bank public sector units (PSUs) in return for excess reserves, in a sort of repo structure. A creative package could have elements of all three. The reason to solve the reserve question first is so that it can “un-stick" the credit quagmire that the economy is in.
PSU governance: Concomitant with recapitalization of PSU banks should be a timetable for governance reform—granting the RBI the authority to regulate PSU banks and creating a government bank holding company that permits a series of board and management changes in PSU banks so that the current problem is not repeated.
Relaxing PCA norms: No patient or bank in the intensive care unit (ICU) can hope to leave without physiotherapy. The RBI believes it is doing a great job by ensuring the patient doesn’t get worse, but the straitjacket that 11 banks find themselves in today is excessively constricting. Of course, capital will alleviate the problem and recapitalization by the government is one option. However, the RBI’s framework will need to evolve to be less rule-based and more discretionary to allow more of these banks to emerge from the ICU, otherwise they risk taking the economy into the ICU with them.
Focus the issues for discussion: The government has done itself a disservice by bringing up too many issues. Topics such as India’s translation of Basel III norms and the appropriate risk weight on a bank balance sheet for credit to small and medium enterprises should be discussed at the RBI board and the executives at RBI should be trusted to make the right decision having received inputs from the board. These items are not worthy of a Section 7 spat that risks the market’s wrath.
Both sides have behaved poorly in the build up to this. Hopefully, wisdom and maturity will prevail at the table. In the longer term, the RBI Act will itself need to be modernized. Public interest will then be protected by a modern central bank that is accountable to the people in a properly structured framework.
P.S: “All have their worth, and each contributes to the worth of the others," said J.R.R. Tolkien.