Centre, RBI can agree to disagree

Ram Singh
Professor, Delhi School of Economics

THE last two months have witnessed a protracted showdown between the RBI and the Centre. Going by media reports on the testimony of the RBI Governor made before a parliamentary committee on November 27, the rift is unlikely to end in the near future. This is disconcerting. Cooperation between the monetary and fiscal policy authorities is crucial for growth and stability of the economy. If they work in the spirit of cooperation, they can make most of the economic benefits possible from the recent fall in crude oil prices.

The RBI decides the monetary policy and keeps a check on inflation by controlling interest rates. It regulates activities of commercial banks to control the supply of money in the economy, and protect interests of account holders. The Ministry of Finance (MoF), on the other hand, controls the fiscal policies through tax rates, subsidy and public expenditure. 

There are four points of disagreement. The first issue is the profits earned by the RBI. The bank earns profit from several activities, such as charging interest on the money lent to commercial banks. It also earns profit from the printing of money. Some of these profits are shared with the Centre, who now demands a larger share.

The second dispute is over RBI’s  large stock of assets, which include Rs 3.6 lakh crore cash reserves accumulated from profits earned over the years. The government wants a share in these reserves. FM Arun Jaitley has argued that the reserves should be used for welfare schemes. But Governor Urjit Patel has maintained that the bank needs them to deal with international volatility and maintain high creditworthiness.

There is merit in both viewpoints. The RBI needs reserves for effective interventions in the foreign exchange and domestic money markets. However, it has not provided rationale behind its assets. At the same time, if the cash reserves are handed over to the government, it can cause high inflation. However, a part of the other assets can be used by the Centre, say to reduce its liability towards private entities. 

In any case, there is need for a policy framework to govern the use of cash reserves and other assets, and the rules for sharing annual profits with the government.

The third dispute is over the prompt corrective action (PCA) initiated by the RBI. At the heart of this issue is the problem of bad loans, also called NPAs.  A bank loan becomes bad if the borrower stops the repayment of instalments or delays them by over 90 days. Since commercial banks earn profit by charging interest on loans, an NPA means a loss for the bank. A high proportion of bad loans can threaten the very viability of the bank. If banks fail, it will hurt deposit-holders as well as the economy.

To address this, the RBI has started the PCA against 12 banks that have high proportion of NPAs. The banks have been asked to improve their balance-sheet by cutting losses, which means that they cannot open new branches and issue new loans. The idea is to make these banks accountable for their bad lending decisions.  However, the result is that these banks cannot lend even for good business projects. 

In addition, following BASEL III norms, the RBI has asked commercial banks to maintain a higher capital to risky assets ratio’ (CRAR), in order to discourage them from lending for risky projects. However, a higher CRAR means the banks would have less capital for lending. Consequently, developers of private projects, including infrastructure, find it difficult to secure funding for their projects. 

On top of it, the non-banking financial companies (NBFCs) have also cut down lending. These companies have been a major source of funds for small and medium-size enterprises (SMEs) and housing projects. Since the crisis of the IL&FS, the pension and mutual funds have cut down their investment in NBFCs who, in turn, have stopped onward lending activities. 

This scenario is especially bad for SMEs that are in distress and find it difficult to borrow from banks. This explains why the government has problem with PCA. 

It is good that in the last board meeting, the RBI has agreed to make concession for SMEs. In addition, it should make distinction between wilful defaulters like Nirav Modi and those who are unable to pay on time for genuine reasons. Many debtors have invested in infrastructure projects that are stuck due to regulatory or legal hurdles beyond their control. Such loans are facing only temporary setbacks. So, banks should not be forced to treat such loans as NPAs. 

The decline in crude oil prices will lower inflationary expectations. The RBI can afford to grant some elbowroom for banks to lend more without compromising on the inflation front. Cheaper crude oil also means lower subsidy burden for the Centre. The government can, and should, infuse the much-needed capital in public sector banks.  

Finally, there is difference of opinion over the role of the RBI board vis-a-vis the Governor and his team. The voices emerging from the MoF suggest that the government wants supremacy of the board in policy making. Monetary policy is essentially an RBI function. The traditional role of the board is advisory in nature and should remain as such. There is no harm in the board advising the RBI on economic issues, but it should not direct the RBI in policy making. The board has members from industry and the banking sector. Those who are to be regulated can’t be decision makers. The Centre is represented on the board by members nominated by it. The government can use this channel to convey its concerns to the bank. Of course, the two sides should hold regular consultations.