Due to the very nature of the mandates of the RBI and the Ministry of Finance of the government, the two wings can never see eye to eye. The Finance Ministry’s mandate is political, to maximize employment and generate rapid growth in the economy while the RBI’s mandate is economic and its one prime role is to minimize inflation
The Reserve Bank of India (RBI) is in the spotlight these days. The reason being the ongoing discussions on the relationship issues between it and the government. The questions being raised are, whether the autonomy of the Central Bank, that is the RBI, under threat? Whether the government is likely to give direction to the RBI under section 7 of the RBI Act, which has never been invoked earlier? Whether the Governor of the RBI will resign? Such questions are making headlines in newspapers and television debates. Opposition parties have also joined the fray and accusing the government that financial institutions are under threat.
To analyses the issues involved, let us begin with some understanding about the RBI (Central Bank). The RBI came into being with effect from April 1, 1935, in accordance with the Reserve Bank of India Act 1934, with the ownership lying in the hands of private shareholders. The central office of the bank was initially headquartered in Calcutta (now Kolkata) and later moved to Bombay (now Mumbai) in 1937 with office at Mint Road. The bank was nationalized with effect from January 1949 after independence. The banking operations in the country and the role of the RBI are covered by the Banking Regulation Act 1949. The RBI is a banker’s bank and also the bank of the government. It is the financial regulator that assumes the role of watchdog on banking matters.
Many roles: Its functions are best summarized by its Preamble which reads: ‘To regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage to have a modern monetary policy framework to meet the challenges of an increasing complex economy, to maintain price stability while keeping in mind the objective of growth.’
For the public in general, RBI is seen as an institution regulating interest rate which affects their EMI, but the fact of the matter is that it has many caps on its head like that of monetary authority, regulator and supervisor of financial stability, currency management authority, foreign exchange authority. The executive head of the RBI is the Governor who is assisted by the Deputy Governors and there is also an apex body of a Central board of directors of maximum 21 members. The board is constituted by the Governor, with a maximum of four Deputy Governors, two senior officials of the Ministry of Finance, four directors from four zonal boards of the RBI and ten directors from different walks of life appointed by the government for four years. Governors are appointed for a normal period of three years which can be extended.
At loggerheads: Due to the very nature of the mandates of the RBI and the Ministry of Finance of the government, it has normally been seen that these two wings normally never keep a friendly relationship. The Finance Ministry’s mandate is political, to maximize employment and generate rapid growth in the economy while RBI’s mandate is economic and its one prime role is to minimize inflation. These are two mutually contradictory mandates. Fiscal policy and monetary policy make for uneasy bed fellows. Since the inception of the RBI, five governors have quit their jobs. These include Osborne Smith (first governor), Bengal Rama Rau, S Jagannathan, RK Puri, and Ram Narain Malhotra, popularly known as R N Malhotra. These facts show historically that the relationship between the two wings (RBI and the government) have remained far from cordial. If seen in the historical perspective, the present strained relationship between the two wings is not an isolated one.
“The government sees from the wider perspective while the Central Bank must see that government is not going wrong in its economic decisions. In the words of Dr Raghuram Rajan, the RBI works as a seat belt for the driver, which is the government”
Not on the same page: The situation was heating up for some time as the government had a feeling that the RBI was not doing enough to give boost to growth. Interest rate was not being reduced despite the fact that inflation rate was much under control and as a result there was no credit off-take. Employment has been the biggest challenge for the government and in the absence of industrial expansion for which soft credit is essential, it was being felt that the RBI was not on the same page with the government. The sudden discovery of huge accumulation of NPA (Non Payment Assets) due to the improper provisioning by the banks in the past was one of the reasons. The government felt that even the RBI (Central Bank) should take some blame for not monitoring properly.
Heated exchanges: The case of Nirav Modi added to this point of view, as the auditors of the RBI failed to detect a systemic failure. Government officials were seen expressing their views and diplomatically targeting the RBI. The strained relationship came into public view when an RBI Deputy Governor delivered a lecture where he clearly warned that the autonomy of the RBI should not be tarnished and he gave an example of the Central Bank of Argentina. There was also a response from the government that directions can be given to the RBI for the betterment of the national economy and if the need arises, even the never used article 7 of the RBI Act can be invoked.
There was a heated board meeting, just preceding the meeting of November 19. The situation cooled down and there was a professional discussion in the board meeting on 19th after the Finance Ministry clearly spelt out that there was no threat to the autonomy of the RBI and that article 7 would not be invoked.
Irking issues: The pressing concerns of the government were articulated and categorically conveyed to the RBI. After the problem of Infrastructure Leasing & Financial Services Limited (IL&FS), it was seen that non-banking finance companies (NBFCs) and even some Mutual Funds which are exposed to them are facing heat due to liquidity problems. Some public sector banks which have become weaker due to NPA were seen to be experiencing more pain due to the Prompt Corrective Action (PCA), a scheme announced by the RBI as they were directed not to give additional loans till the problem of NPA was cleared or there was more introduction of capital. Then there was an issue of urgent consideration of loan restricting by MSMEs due to the liquidity issue. The circular issued by the RBI in February, 2018 where even a one day default by the borrower in repaying to banks would make the loan an NPA and its provisioning as a result would make the bank a loss making entity, was seen as uncharitable to the financial sector.
Last and not the least was the issue concerning the capital framework of the central bank. There is a point of view that reserves of about Rs.10 lakh crore accumulated by the Central Bank is much in excess of the established norms of capital formation by other central banks of other countries. A study in 2014 said that about 1.14 lakh crore is in excess even applying the most liberal parameters. There was a lot of discussion in the media that the government wanted to take a sizeable amount of Rs three lakh crore from the reserves of the RBI in the election year to do more spending and also bridge the looming fiscal deficit. There was some cooling down when the government clarified that it is not interested in taking any part from the accumulated reserve, but it only wants that there should be a scientific framework for adding to the reserve in the future and that excess profit should go to the government as logical dividend and not as ad hoc dividend. Both, the government and the Central Bank have seen maturity and have decided to consider the issues rather than create any situation which will harm the image of the country. The meeting of the RBI Board on 19th November 2018 is a step in the right direction. (This column is written before the next meeting scheduled to be held on December 14, 2018). The issues raised were discussed and a press release of the RBI after the meeting is self-explanatory about the concern shown by the RBI to address them.
The press release: “The RBI Central Board met today in Mumbai and discussed the Basel regulatory capital framework, a restructuring scheme for stressed MSMEs banks health under Prompt Corrective Action (PCA) framework and the Economic Capital Framework (ECF) of the RBI. The Board decided to constitute an expert committee to examine the ECF, the membership and terms of reference of which will be jointly determined by the government of India and the RBI. The board also advised that RBI should consider a scheme for restructuring of stressed standards assets of MSME borrowers with aggregate credit facilities of up to 25 crore. The Board while deciding to retain CRAR at 9% agreed to extend the transition period of implementing the last tranche of 0.625% under the Capital Conservation Buffer (CCB) by one year i.e. up to March 31, 2020. With regard to banks under PCA, it was decided that the matter will be examined by the Board for Financial Supervision (BFS) of the RBI.”
Discussion a must: In a democratic country discussion between two wings of the government is necessary to evolve the right recipe for a healthy nation. There can be disagreement on some issues but that does not mean that there is anything wrong in the system. The government sees from the wider perspective while the Central Bank must see that government is not going wrong in its economic decisions. In the words of Dr Raghuram Rajan, the RBI works as a seat belt for the driver, which is the government. Section 7 of the RBI Act is for an extreme situation if something good needed for the country is not being considered by the Central Bank despite advisory meetings.
Today, India is the fastest growing major economy in the world. It is the sixth biggest economy bypassing France. In the ease of doing business index, India has quickly jumped many steps in a short time of four years. This is possible only when all the wings of the nation contribute positively and this means that both RBI and the Finance Ministry are doing good work collectively and harmoniously. Adverse publicity of some heated situation should be avoided for the sake of the good image of our country.
by S K Jha
