Photo: Mint
Photo: Mint

Opinion | Reserve Bank vs the government: Peace in our time?

The question of capital return, though it appears to be the most intractable, is the easiest one

The bland statement issued after the meeting of the Reserve Bank of India (RBI) board on 14 December, the first one under the chairmanship of Shaktikanta Das, is an indication that both the government and the governor are keen to mend fences. The statement mentions, inter alia, that the board discussed the “governance framework" of the central bank, but didn’t tell us anything more than that it “required further examination". That is bureaucratese for saying that the issue will slowly be swept under the carpet.

That is a good thing, for there can be no question of the RBI board playing anything more than a strong advisory and feedback role. It is enough if the RBI does not treat it as a mere rubber stamp, an entity whose opinion doesn’t matter in the formulation of regulatory policies.

The statement also said that the board reviewed “the current economic situation, global and domestic challenges, matters relating to liquidity and credit delivery to the economy, and issues related to currency management and financial literacy". Ho-hum. It’s as if the weather was being discussed.

The sheer brevity of the statement suggests that on all these issues, both sides will spar in private, and come to some sort of compromise before the board is brought into the picture again. The fact that a finance ministry outsider like Urjit Patel is gone and his replacement is an insider augurs well for the future of this crucial relationship between the monetary and fiscal authorities. India is too complex a political economy for either of them to carve out completely separate spaces for action without consultations.

One can surmise that the government and the governor have bought time to work out compromises behind the scenes. While governance issues will be sidelined as the two sides are on talking terms again, it leaves us with the issues that won’t go away without a resolution.

Among them the question of return of some of the central bank’s “excess capital", finding a way out of the prompt corrective action (PCA) framework for 11 public sector banks, improving liquidity for non-banking financial companies (NBFCs), and increasing the flow of credit to micro, small and medium enterprises.

The question of capital return appears to be the most intractable but is actually the easiest one to tackle, provided the RBI does not take the approach that it is none of the government’s business. While former chief economic adviser Arvind Subramanian has been vocal on the issue of excess capital, some global financial commentators are even suggesting that capital return is a non-issue.

Christopher Wood, CLSA’s chief strategist, commented in Greed & Fear that “the RBI balance-sheet is as overcapitalised as the [US central bank] Federal Reserve’s is undercapitalised". Wood estimates that the RBI’s capital-to-assets ratio is 30% compared to the Fed’s 1%. CLSA is a leading brokerage and investment group.

Overcapitalisation basically means inefficient use of capital and the first thing any central bank should be worrying about is whether it is wasting capital that can be put to better use.

It is worth recalling that till 2006-07, the RBI owned nearly 60% of the State Bank of India (SBI), and following amendmentsto the SBI Act, the RBI sold these shares to the government for a hefty profit of 34,300 crore. The government clawed this profit back by way of higher dividends.

In short, the transaction was largely a book operation. The same thing can now be done in reverse, where the government can ask the RBI to jointly invest 75,000-1,00,000 crore in weak banks after putting them in a holding company and giving the managements clear, measurable
performance objectives. Once these banks turn around, the RBI can sell the shares in the holding company back to the government or the markets and the government can get the excess capital
back as dividends from the RBI’s resultant profits.

Once the capital return problem is solved, the rest of the issues look minor. The banks under PCA restrictions are obviously the ones to be capitalised by the RBI and can be let out of the cage quickly to begin lending again.

Once lending resumes, banks can incrementally buy out stressed—but good—NBFC assets, which will ease the liquidity problem. More credit flows to micro, small and medium enterprises can be guaranteed through a new mechanism under which bank assets are partially back-stopped by a form of an additional credit guarantee—again partially paid for from the Reserve Bank of India’s excess capital.

Overall, the entry of Shaktikanta Das bodes well for peace between Mint Street and North Block. If no one is sitting on a high horse, it will be peace in our time.

The author is editorial director, Swarajya magazine.

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