Impact of Nov-19th meet between RBI and government

Reserve bank of India Impact of Nov 19th meet between RBI and government

The meeting between the RBI and the government on 19th November ended on a fairly conciliatory note. For now there is no immediate risk of the RBI governor resigning. The RBI governor had stated that he would be forced to resign if Section 7 of the RBI Act was invoked as it would have resulted in a clear curtailing of the powers of the RBI. Globally, central banks have worked hard to maintain their independence and even in India, this section has never been invoked in the past. Here are the highlights of the RBI meeting with the Finance Minister on 19th November.

Highlights of the meeting between RBI and the Finance Minister on 19th November

  • On the liquidity front there was a near consensus between the RBI and the government. The RBI had already infused Rs.40,000 crore via OMOs into the financial system in November and has now committed to infuse another Rs.40,000 crore in the month of December. Of course, the total shortfall is to the tune of Rs.100,000 crore so this may still be insufficient. However, this should be positive for the sentiments of the money market for the time being.
  • RBI has agreed to increase the credit for small and medium enterprises (SMEs) via banks. In the last couple of years, MSME growth has fallen to single digit, which was a huge drag on the employment and production capacity of the MSME sector. The RBI has agreed to coax banks to be more liberal in lending to the MSME sector as the sector is already under strain in the aftermath of the demonetization and the launch of GST.
  • RBI is also agreeable to the idea of ensuring the free flow of credit to the NBFC sector. This would be linked to the SME situation above since the NBFCs are now accounting for most of the incremental credit to the SME segment. Also, since NBFCs handle the last mile lending on behalf of banks, they have an important role to play. SBI has already committed to increase the lending to NBFCs threefold from Rs.15,000 crore to Rs.45,000 crore. This should ease the flow of credit to the realty sector and to small businesses. In fact, RBI has also agreed to the recast of some of the SME loans that merit a recast, based on past record and where the problems are more related to the cycles.
  • There was elaborate discussion on the PCA framework. Currently, banks classified under the prompt correction action (PCA) have severe restrictions on the expansion of branches, top management compensation and on expanding their loan books. This was proving to be a drag because the deposits were growing and that had to be serviced. However, these deposits could not be deployed in lending and that created a headache for the banks as they were going into negative spreads. The RBI has agreed to give some leeway on PCA bank lending purely based on seriousness shown by these banks in NPA recovery and in case of banks that were potential merger candidates. However, the RBI has clarified that any blanket lifting of the PCA bank may not be possible.
  • The big debate was on the subject of capital transfer to the government and sharing of the RBI surplus. As of now there is no precedent for the same but the government had asked the RBI to transfer Rs.100,000 crore from its surplus reserves to the government account. RBI has expressed reservations about the central bank becoming undercapitalized. Both the RBI and the Finance Ministry have agreed to appoint a high level committed to look into this issue from a lateral perspective and then take a final decision. For now the transfer may not be done and it has been put off to a later date.

There has not been a lot shared by the RBI or the Finance Ministry about the nuances of the discussion between the RBI and the Finance Ministry for now. Section 7 of the RBI Act allows the government to issue orders to the RBI on issues of larger public interest. It is not clear whether the same has been invoked or not. But for now, there has certainly been a truce and that should go down well with the markets. Markets hate uncertainty, especially if it represents the two highest bodies regulating the financial markets.

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