Government versus RBI: What caused this?

Government Vs .RBI  Government versus RBI: What caused this?

Differences of opinion between the government and the RBI are nothing new. It has been in existence from the days when Dr. Manmohan Singh was the governor of the RBI in the 1980s. It is just that the differences have become more pronounced in the last few years as the conflict of roles has come more in the open. The RBI has a singular objective of managing interest rates and maintaining price stability. The government, on the other hand, also has the objective of pushing up GDP growth. While the government may require a greater push to growth with liquidity flows and lower interest rates, the RBI is always more committed to keeping interest rates in tandem with the rate of inflation.

Differences of opinion between the RBI and the government

The differences of approach between the RBI and the government actually came upon four major counts as under.

  • In the light of the NBFC crisis, the government was keen to infuse more liquidity into the system via banks to ensure that the NBFC sector is not impacted. The NBFC sector is an important last-mile deliverer for banks and plays a critical role in the delivery of credit. Post the IL&FS fiasco, the RBI had turned tough on NBFCs, which the government was not too comfortable with.
  • There was also a difference in approach on the interest rates trajectory. The government has been insisting for long for a more dovish interest rate policy. The RBI had raised rates by 25 basis points in June and August. This had led to serious differences of opinion as the government felt that it would stymie growth in the economy. While RBI has maintained status quo on rates in October, any rate cuts have been ruled out till inflation is structurally under control.
  • Thirdly, there is a major difference in the way the RBI and the government want to approach the PCA banks. The PSU banks that were vulnerable were identified by the RBI for prompt corrective action (PCA). Apart from restrictions on top management pay and branch expansion, these banks also had restrictions on credit expansion. The government wanted the RBI to be more liberal in allowing PCA banks to lend to corporates. The RBI, on the other hand, worried that it would lead to dilution of PCA.
  • Finally, the biggest difference arose on the use of RBI capital. The government had asked the RBI to transfer nearly Rs.100,000 crore from its capital surplus into the government account. While this did not have a precedent, the RBI was of the view that it would seriously jeopardize the capitalization of the central banks. The government has asked for this transfer from RBI to help them meet the shortfall in resources for this fiscal year.

What exactly is Section 7 of the RBI Act?

There is a special Section 7 in the RBI Act which authorizes the government to direct the RBI to perform in a particular manner. This Section 7 has never been used before in the interest of central bank independence. Most central banks like the Federal Reserve, Bank of England, ECB and the Bank of Japan have zealously guarded their independence. Section 7 would have substantially diluted the powers of the RBI and its independence would have been largely compromised. In fact, the governor of the RBI had also stated his intent to resign from his position if  Section 7 was invoked by the government.

popular NBFC Government versus RBI: What caused this?

But, things have been sorted out for now

The November 19th meeting between Mr. Jaitley and Dr. Patel turned out to be much cordial and conciliatory than the markets expected. For starters, the RBI has agreed to provide liquidity support to the NBFCs via banks. This is obvious with SBI announcing its intent to triple its funding support for NBFCs from Rs.15,000 crore to Rs.45,000 crore. Secondly, the government and the RBI have agreed to be a little more liberal with the PCA banks so that banks do not end up with a mismatch wherein they have to service deposits but cannot lend to customers. The capital return issue has been put off for now (which was the real bone of contention) and is likely to be referred to a committee of experts. There is no clarity on Section 7 but at least some reports claim that there is likely to be government involvement in RBI decision making.

For now, the things appear to have been sorted out. The truce appears to be in place, albeit an uneasy truce!

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