RELATIONS between finance ministers and bureaucrats in the ministry with the Reserve Bank of India (RBI) have always been tenuous, with many former heads of the central bank wanting to chart an independent path, much to the dislike of most governments over the decades.

But recent days have seen tempers flare among the key players including Finance Minister Arun Jaitley and some of his senior bureaucrats on one side and the top RBI bosses trying to maintain the institution’s independence.

Indeed, the National Democratic Alliance (NDA) government headed by Prime Minister Narendra Modi with Mr Jaitley as his finance minister has had an uneasy relationship with the central bank since it came to power in 2014.

Former governor Raghuram Rajan, who was made the central bank’s chief in 2013 when the Congress-led United Progressive Alliance (UPA) government was in power, had major differences with Mr Jaitley and several other Bharatiya Janata Party (BJP) leaders.

When his term came to an end in 2016, the government did not grant him an extension and brought in Urjit Patel, who was then seen as someone close to Mr Modi.

While it has not officially acknowledged the fact that it has sent notices to the central bank under the RBI Act, the finance ministry said it would continue to suggest possible solutions to resolve the issues

But recent months have seen a sharp deterioration in relations between the RBI and the finance ministry. Earlier this year, the RBI demanded strict enforcement of the Prompt Corrective Action (PCA) framework to prevent a crisis engulfing the banking sector.

The RBI demanded that 11 of the weakest banks be brought under the PCA. It believed this was essential to prevent a major banking crisis in India. The PCA would make lending to the micro, small and medium enterprises (MSME) sector difficult.

The government, however, wanted easing of lending norms for the MSME sector, which generates the largest number of jobs, accounts for 45 per cent of GDP and about 40pc of exports. The BJP-led government, which will be facing the electorate in less than six months in general elections due to be held in April-May 2019, wants to ease the norms relating to MSME sector in the country.

Many observers believe that the bulk of the support for the BJP is from this segment comprising small businessmen, traders and merchants across India.

The demonetisation of the Indian rupee by the Modi government about two years ago hurt this segment the most; obviously, the BJP does not want support from this key segment to disappear, analysts believe, resulting in pressure on the RBI to ease the lending norms.

The RBI also came out with a circular in February, directing banks to treat loans delayed beyond the 90th day as a non-performing asset (NPA). The move raised the NPAs by more than a quarter, adding up to a hefty Rs10 trillion.

Relations between the government and the central bank worsened, when Viral Acharya, the deputy governor of the RBI — who had worked in the UK and the US for more than 15 years before being appointed to the top position — criticised the government for undermining the autonomy of the central bank by interfering in its decisions.

Last month, Mr Acharya virtually lashed out at the government, claiming that when the central bank’s independence is violated, it would trigger an economic crisis and result in a backlash from the financial markets. The ‘potentially catastrophic’ act could incur the wrath of the financial markets, he warned.

He also cited the example of Argentina, where interference by the government in the affairs of the central bank in 2010 led to a market revolt and a surge in bond yields.

Of course, the government hit back and Mr Acharya’s views were punctured with officials claiming that Argentina had defaulted on its international debt more than half a dozen times, unlike India which had never defaulted on debt.

Earlier this month, Mr Acharya added fuel to the fire, comparing the government’s view of the economy to a T20 cricket match, as against the RBI’s long-term view which was like a test match.

THE Indian government, however, was not willing to take such opposition lying down, especially with Mr Acharya’s boss, the governor, refusing to intervene.

While it has not officially acknowledged the fact that it has sent notices to the central bank under the crucial section 7 of the RBI Act — which empowers the government to give directions to the RBI — the finance ministry said it would continue to suggest possible solutions to resolve the issues.

The government sought an easing of the tight norms on PCA against banks, reclassification of non-performing assets of power generation firms and transfer of a hefty sum of Rs500 billion as dividend by the central bank.

The tense relationship resulted in the RBI board meeting to discuss the crisis; the board, which also includes senior bureaucrats (obviously siding with the government), decided to refer the matter to an expert committee.

Recent days, however, have seen a cooling down in the heated relations between the government and the central bank.

And last week, Mr Patel appeared before a 31-member parliamentary standing committee on finance, which incidentally was headed by M. Veerappa Moily, a Congress leader, and included Manmohan Singh, the former Prime Minister and also a former governor of the RBI.

But the governor did not refer to any of the recent controversies and focused on addressing issues relating to demonetisation and the growing non-performing assets of public sector banks.

Mr Patel also told the MPs that the Indian economy would get a boost following the sharp fall in the price of oil, which has slid to $50 a barrel, against fears a few months ago of its touching $100. The RBI governor further told the parliamentarians that the fundamentals of the Indian economy were robust.

Incidentally, both the government and the RBI were advised by Vice President M. Venkaiah Naidu last week to resolve their differences through regular dialogue at the earliest.

“The Reserve Bank of India and the government of India must have a regular and continuous dialogue,” he suggested. “There is no question of who is powerful or who is final. Final are the people and their interests. All these systems are created to facilitate people’s welfare.”

Published in Dawn, The Business and Finance Weekly, December 3rd, 2018



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