RBI Vs Govt: Is Finance Min’s Statement Enough To Calm Nerves?

The finance ministry has released a statement on the RBI row. But is that enough to calm the nerves?

Left to Right: RBI Governor Urjit Patel and Finance Minister Arun Jaitley.

(Photo: PTI)

Amidst the public glare on differences between the government and the Reserve Bank of India, the Finance Ministry on Wednesday, 31 October, issued a statement saying that the autonomy of the central bank is essential “within the framework of the RBI Act.”

The statement, which followed reports that the government may initiate consultations under a never-used provision that allows it to direct the central bank in “public interest”, did little to address the differences that have emerged on key policy matters. All the government said in its statement was that both the central bank and the government must be guided by “public interest.”

The autonomy for the Central Bank, within the framework of the RBI Act, is an essential and accepted governance requirement. Governments in India have nurtured and respected this. Both the Government and the Central Bank, in their functioning, have to be guided by public interest and the requirements of the Indian economy.

RBI Statement

The statement went on to add that extensive consultations take place between the government and the RBI from time to time. The subject matter of these consultations is not made public and only final decisions are communicated, said the Finance Ministry.

“The government , through these consultations, places its assessment on issues and suggests possible solutions. The government will continue to do so.”

The statement from the government is very bland, columnist and author TCA Srinivasa Raghavan told BloombergQuint, reacting to the development. “The government couldn't have said anything more or anything less. All that they have said is that we consult with these institutions and we will continue to do so. It’s a very bland statement.”

Still, the statement helped calm the currency markets to some extent. The rupee which had been trading sharply weaker since the morning, rebounded from the day’s low in response to the government’s comments.

The “terse” statement was welcome, because the expectation was a worst-case outcome, said Ananth Narayan, associate professor (finance) at SP Jain Institute of Management and Research. “We should have never gotten to this point, this is a situation that we can do without,” Narayan, a veteran watcher of the Indian markets told BloombergQuint.

RBI Reserves: The Key Issue?

The issues that have cropped up between the RBI and the government range from banking regulation to payment systems and the central bank balancesheet. Neither the government nor the RBI has signaled any thaw of any of these specific issues yet.

These issues were detailed in a speech by RBI deputy governor Viral Acharya in a speech on Friday, which, in many ways, brought the differences between the RBI and the government into the public domain.

Acharya cited demand on the RBI to ease the prompt corrective action framework as one pressure point. Eleven government banks are under this framework, making it hard for them to expand their lending meaningfully. The government has been seeking a relaxation of this framework.

A recent suggestion to create a payment regulator outside the purview of the Reserve Bank has also been opposed by the RBI. In a dissent note, the RBI said that regulation of payment systems is central to the functions of a central bank.

Perhaps the most contentious issue remains that of the RBI’s reserves and capital on the central bank’s balance sheet. Citing research from various academics and writings from former RBI Deputy Governor Rakesh Mohan, Acharya noted that having adequate reserves and capital is important for maintaining confidence in the central bank.

Experts that BloombergQuint spoke to said that the debate over the reserves and capital of the RBI is the most serious of the issues being debated right now. “The government wants comfort on fiscal deficit, RBI wants to maintain sufficient reserves,” said V. Anantha Nageswaran, Dean at IFMR Business School.

“The real issue is clearly on the reserves because the government is struggling to meet the fiscal deficit target for 2018-19. But given the fact that we have had three rounds of NPAs crises over the past few decades, I think the RBI correctly feels that for it to be a ‘lender of last resort’, it needs to have excess reserves. I think there is a certain case for it. Whether the government reports a fiscal deficit number of 3.3 percent of 3.5 percent, it should bite the bullet.”

V Anantha Nageswaran, Dean at IFMR Business School. 

Ananth Narayan noted that while there may be a case to argue that the RBI is sitting on excess capital, the issue has to be debated extensively before any decision. “While we are speculating, it appears that the issue that broke the camel’s back is the RBI’s reserves....One of the sad things would be if we try to do something without having enough debate about this,” said Ananth Narayan while adding that the financial markets will see through any attempt to fill the fiscal hole using RBI’s reserves.

I think most people will see through this, he added.  

Breakdown of Communications

While a number of specific issues have cropped up between the central bank and the government, an over-arching problem has also been the break down of communications between the two sides.

“I think it (the stand-off) is a combination of immaturity both on the part of the government and the RBI,” said columnist Sanjaya Baru. “The bottomline is that at the end of the day the Government of India is the sovereign and the buck stops with them. Central bankers always know that the last word is that of the government of India and not theirs.”

TCA Srinivasa Raghavan took a similar view.

“I have no idea to what extent this is about the issues and to what extent there are major egos involved. It’s very hard to say,” he said while recalling the back and forth that would go on over interest rates between former RBI Governor D. Subbarao and former Finance Minister P Chidambaram.

In a conversation with BloombergQuint on Tuesday, former RBI Deputy Governor Rakesh Mohan had urged both sides to refrain from airing differences in public.

“The government should refrain from airing such differences publicly and, of course, that goes the other way around as well,” said Mohan while adding that he is not privy to the provocations that led the RBI to come out so publicly. “I do hope that saner heads will prevail.

(This article was first published on BloombergQuint and has been republished with permission.)