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RBI vs FinMin: Why tinkering with RBI is a recipe for disaster

After partial formalisation of the economy through sudden demonetisation of high value currency notes and the implementation of Goods and Services Tax, there are efforts to formalise the 83-year old Reserve Bank of India too.

twitter-logoAnand Adhikari | November 22, 2018 | Updated 14:44 IST
RBI vs FinMin: Why tinkering with RBI is a recipe for disaster

After partial formalisation of the economy through sudden demonetisation of high value currency notes and the implementation of Goods and Services Tax (GST), there are efforts to formalise the 83-year old Reserve Bank of India (RBI) too. It is an open secret that the finance minister and the RBI governor always consult with each other on major issues impacting the economy. The RBI as a regulator of banks (where over two third of the banks are public sector banks), and while managing the government securities, monitoring the rupee value or deciding the monetary policy always takes a conciliatory route to get a sense from the government.

Just a few months ago, the finance minister, the prime minister and the RBI governor sat together to announce a slew of measures to arrest the rupee's free fall against the US dollar. In fact, much before the creation of the monetary policy committee (MPC), the RBI governors used to make a customary round to the North Block in Delhi to apprise the finance minister of the operating environment under which the policy would be framed.

The former governor D Subbarao had written in his book -- Who Moved My Interest Rates? Leading The Reserve Bank Through Five Turbulent Years -- about the style of two finance ministers, P Chidambaram and Pranab Mukherjee in the UPA government, under his tenure as a governor. He wrote Chidambaram always used to meet him alone, while Mukherjee would have all the secretaries doing the talking. There is also an anecdote from the former governor who in monosyllables explained all his answers on a call he once received from the Finance Ministry.  The replies went something like this: No, No, No, Yes, No, No, No." The only 'yes' was to the FM's question of whether he heard him properly. But that may be an exception as there are always consultations on most of the issues now.

There are now voices against the current RBI governor Urjit Patel as being inaccessible. But what he did on the non performing assets (NPA) and Prompt Corrective Action (PCA)'s front was earlier supported by the government. In fact, the government took all the credit for starting the clean-up drive against bad loans and cleaning the banks' balance sheet. "It is difficult to ask the person (governor) to suddenly slow down when you have created a highway for him to go after defaulters and weak banks," says a banker.  

As a protector of the institution, the buck stops with the governor. He is truly responsible and accountable for the decisions RBI takes. You just cannot force the RBI governor to do something and later throw him in the fire to face the wrath of the financial markets or go down in the history as the one who gave in to the political pressure. Many insiders are revealing another dimension to the fight between the government and the RBI. They say, RBI has indeed ceded some ground, but quite reluctantly. There are records of what the RBI pushed for and what concerns it raised in the board meetings and also the implications of relaxing the prudential guidelines. For instance, if the government takes away surplus and there is a mismatch tomorrow as the RBI is also a lender of the last resort, everyone knows whom to blame or take to the task. The responsibility or accountability will not stop at the doors of the RBI governor. For example, the RBI's scheme of allowing gold imports under 80:20 scheme for private players had put the then finance minister P Chidambaram in the dock as the decision came from the finance ministry. Today, the RBI has put its caveat on each of the issues ranging from surplus capital, liquidity for non banking financial companies (NBFCs), PCA norms to restructuring of micro, small and medium enterprises (MSMEs) before the board. And if the board agrees, it should also share the responsibility and accountability if something goes wrong tomorrow. For instance, if the RBI board agrees to release a few weak banks from its PCA framework and few months later, some of these banks stumble or go bust, then everyone (depositors) knows who to catch.   

Similarly, the very purpose of creating a bankruptcy code was to allow companies to fall, restructure or encourage buyouts. The government has recently relaxed the guidelines for MSME promoters to allow them to bid for their own assets. When such a window is available to restructure the loans, why do MSMEs need another window to restructure loans? There is no end to such relaxations as successive governments keep enhancing the loan threshold to cover as many MSMEs as possible under the restructuring schemes. On the capital adequacy, the RBI got all the praise post 2008 for its conservative policies. While the world saw banks going bust in the most advanced economies, India was insulated because the RBI always restricted the leverage and kept the capital adequacy levels higher than the global standards. Today, the government nominees and some independent directors are rooting for lower capital adequacy ratio or reduced capital buffers. This is a recipe for disaster if there is a financial crisis tomorrow.  The IL&FS accident recently surprised everyone and made the RBI more guarded on such hidden risks in the market. Raghuram Rajan, the former RBI governor, had recently reminded the government (the driver) about the importance of seat belt (RBI). And the man who is talking about the seat belt is the one who predicted the last financial crisis. You can ignore him at your own peril.

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