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The RBI vs The Government Battle: Who Wins What

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India’s government and the central bank have had disagreements in the past, but their relationship has never looked so irretrievably broken as it does now. For the past few weeks, there has been an unprecedented bitter battle between the two. The points of contention include the government’s demands of Rs13000 crore from the RBI’s capital reserves and for RBI to ease lending norms to small businesses

This difference in stance led to months of friction within the RBI with an Oct. 26 speech by RBI deputy governor Viral Acharaya, in which he warned of the “potentially catastrophic” consequences of government interference. Things hit a crescendo in the following weeks with talks rife of governor Urjit Patel even quitting his position. But no country’s Central Bank can function smoothly with the top post vacant and so both RBI and the government forced themselves to find a solution.

After a nine-hour long board meeting that was held on Monday, 19th November, both parties seem to have come out super happy. Reason? The two struck a mutual give-and-take solution.

What the RBI gives

  1. Relaxed ruled for MSMEs

The RBI finally gave in to the government’s demands to relax the bad-loans norms for micro, small, and medium enterprises (MSMEs).

MSMEs are one of the highest contributors to the country’s NPAs (and have a higher probability to default on their loans). But at the same time, they’re also the backbone of the economy because of their high growth potential. The economy needs start-ups and small businesses to grow and so the government wants to ease RBI norms for them.

The government has proposed that the RBI restructure its rules for MSME that have taken loans of up to Rs25 crore. If such MSMEs are unable to pay their loans they won’t directly be considered an NPA. Instead, the RBI has been asked to increase the period after which an MSME will be categorized as NPA from 90 days to up to 180 days.

This move will come as a huge relief to the cash-strapped sector. The government has been looking at various ways to ease cash flow into this sector, which is one of the worst affected by the demonetization drive.

  1. Liquidity to the government

Every year, the RBI transfers a certain sum to the government as dividends. This year, the Modi government had been angling for approximately Rs13,000 crore additional dividends, irking Patel and team for the same. But the central bank rejected the government’s demand, which became the primary contention in RBI-Govt. friction.

The government is agitated because it believes RBI’s total reserves stood at Rs9.6 lakh crore at the end of its financial year ended June 2018 (the RBI follows a July-June calendar), up from Rs8.38 lakh crore in the previous year. This means that it has anyway been increasing its surplus and so should not have any problem transferring some of it to the government.

In fact, a couple of days ago, S Gurumurthy, a government-appointed nominee on the RBI board had said that the Central Bank already had reserves worth up to 28% of its assets while, studies suggested that the reserve should be maintained between 12% and 18.76% of its assets.

But the RBI believes that transferring more money from its surplus to the government is a “bad economic move”. It has already been providing up to Rs60000 crore to the Centre every year. Any more money beyond that will be counterproductive. This is because, the money given to the government is usually used in civic and development activities (building, construction, poverty schemes, etc.) that generate no return or profit.

But despite such arguments, the RBI in the Monday meeting caved in to government pressure and agreed to provide a maximum of Rs8000 crore (as opposed to their demand for Rs13000 crore).

  1. Relaxed PCA norms

Following an increase in bad loans, the RBI had put 11 banks under a PCA framework. Under the PCA (Prompt Corrective Action), several restrictions were placed on banks till their financial positions improved. Banks were barred from carrying out normal banking activities like lending and investing, which brought more damage to the banks.

If banks can’t lend money at high interests, how will they earn profits to repay the bad debts. And if they can’t repay the loan, their credit rating will reduce, discouraging citizens from investing in those banks. In this way the whole banking sector got stuck in its own loop of NPAs, making the government the sole rescuer.

After the Monday meeting, S. Gurumurthy, a government-apointed director on the RBI board, underlined the need to relax norms under PCA, pointing out that India was a bank-driven economy. And so it was done.

What the government gives

Surpluses and Dividends

Since RBI’s surpluses were the main reason for its friction with the Centre, it came up with a solution that would appease the government, for now at least.

The RBI board has decided to set up an expert committee to examine the Economic Capital Framework (ECF) of the central bank, which deals with the surpluses of the RBI. This committee will look into the feasibility of the government’s demands for an increased share in the surplus.

Nonetheless, the Central Bank has to maintain a minimum reserve or say, a certain amount of money as a safety net, that it can use in case of utmost emergency. This is called the capital adequacy ratio (CAR). The RBI has decided to keep its CAR at 9%, which means that for every Rs1 crore surplus, the RBI must reserve Rs 9 lakhs as CAR that cannot be lent out. The government had previously asked the RBI to relax the CAR to 8% so that more funds are available for lending. The latter, however, didn’t budge.

 

It can be assumed from all this that the Reserve Bank of India and the Central government have calmed their differences for now, coming up with solutions that make both side happy.

Parts of this article were originally published in The Print and Quartz India.

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