Opinion | An uneasy truce, but will it sustain3 min read . Updated: 21 Nov 2018, 06:46 AM IST
The compromise between the government and the central bank is a good first step
The Reserve Bank of India (RBI) signalled a truce on Monday after a marathon nine-hour board meeting, agreeing, among other things, to allow banks to boost lending to small businesses. The central bank also agreed to study a demand for transfer of its reserves to the government, although it didn’t concede to the demand.
While the meeting supposedly ended on a cordial note, most will agree that this is an uneasy truce with much of the friction that exists between the government and the central bank remaining unresolved.
Even so, it is a welcome step that the two warring parties have stepped back from the brink and have agreed to find a middle ground. After days of open sparring and the government holding out a threat to invoke the never-used Section 7 of the RBI Act that gives the central bank’s board the power to take decisions in public interest, markets will heave a sigh of relief that the hostilities between the two arms of the government have ended, even if it’s temporary.
It’s not just in India. Central banks everywhere, from Turkey to the US, are under increasing pressure from the governments. While central bankers say that they need to be free from pressures from the governments and lobby groups to focus on their job of containing inflation and maintaining financial stability, their critics say that they are too secretive and have leaned in favour of big financial institutions over the interests of common citizens they are duty-bound to serve.
Even so, the government must shield the central bank from the pressures of day-to-day politics and maintain its independence. At stake is the confidence of foreign investors in the institutions of the world’s fastest-growing major economy. History is witness that confidence, once lost, takes a long time to recover. A case in point is Latin American economies where investors, after burning their fingers because of fiscal profligacy, have occasionally flirted with but never offered any long-term commitment. India should avoid that trap.
The compromise between the government and the central bank is a good first step. What’s now needed is a detailed plan to de-escalate the heightened tension that had investors on the edge for the past few weeks.
The regulator is best placed to decide how much capital buffers banks should maintain. The central bank did well to not bring down the capital adequacy ratio in line with bare minimum levels prescribed under Basel III norms. Instead, it has provided an extra year for banks to implement the capital to risk weighted asset ratio at 9%, giving the stressed public sector banks a breather. Although deferring the implementation of the norm by a year to 31 March, 2020, will not breach international norms as the RBI had originally intended to meet the norms a year in advance, Moody’s Investors Service on Tuesday termed the move as credit negative for the country’s state-run banks. This potentially increases the cost of borrowings for Indian banks, and highlights the perils of government tinkering with central bank functioning.
The RBI also seems to have held its ground on the contentious issue of opening the liquidity tap for non-banking financial companies (NBFCs). Instead, the central bank said it would inject ₹ 8,000 crore into the banking system through open market operations. This indicates that the government has failed to present convincing-enough data to persuade the RBI to address the liquidity shortage faced by NBFCs.
Another concession that the RBI made was to consider a scheme for restructuring of loans to micro, small and medium enterprises (MSMEs) with a maximum borrowing of ₹ 25 crore on the advice of its board. Although much depends on how the RBI implements this, the move may help alleviate the problems faced by thousands of small enterprises that were hit hard by demonetization in 2016 and the implementation of the goods and services tax the following year. The health of these small businesses is crucial for the government in an election year and may help thaw the frosty relationship between the two parties. India’s 65 million MSMEs employ as many as 120 million people.
While tension between the government and the central bank is inevitable with crucial elections due over the next six months, a healthy and functional relationship between the fiscal and monetary arms of the government is necessary to maintain India’s long-term economic growth and lift millions of its citizens out of poverty.
As central banks the world over exercise powers that impact a wider section of society, politicians are more likely to intrude into their domain. Central banks have to work harder to maintain their independence.
Will the central bank manage to work free of interference? Tell us at firstname.lastname@example.org