NEW DELHI (Reuters) - A protracted tiff between the Indian government and the Reserve Bank of India (RBI) climaxed on Monday when central bank governor Urjit Patel resigned, days before a board meeting where he would have faced intense pressure.
A majority of the 18-member board had been expected to demand the RBI reduce curbs on lending and make governance changes that would give the board more say in the central bank’s policies, according to sources familiar with the matter.
Patel’s surprise resignation, which he said was effective immediately, is likely to give the board more leeway to push through its demands as Prime Minister Narendra Modi tries to boost the economy before a national election due by May.
“We look forward to meeting on Dec. 14 to discuss the pending issues,” said Sachin Chaturvedi, a member of the board who supports the government, adding that they still needed to address a liquidity crunch faced by small businesses.
A speech by RBI Deputy Governor Viral Acharya on Oct. 26 blew the lid off a toxic dispute between the central bank and Modi’s government over monetary policy and who controls the institution’s reserves.
While historically there have been differences between the RBI and the nation’s governments, the extent of the rift and its public nature were unprecedented.
The RBI is not statutorily independent, as the governor is appointed by the government, but it has enjoyed broad autonomy in regulating the banking sector. It is mandated to control inflation within a 2-6 percent range while keeping in mind India’s economic growth objective.
HERE ARE SIX CRITICAL AREAS OF CONFLICT:
- The government has wanted the RBI to hand over more money from RBI reserves to help fund its fiscal deficit and give it more flexibility for government spending plans. The RBI currently hands over profits earned from various activities in the form of a dividend. But the government also wants to tap a share of the RBI’s 3.6 trillion rupees ($48.73 billion) of capital reserves. The RBI has consistently rebuffed the demand.
However, the RBI board - on which the government now has majority support - is seeking the formation of a committee to decide on a specific method of transferring surplus reserves.
OUT OF THE SHADOWS
- The government wants the RBI to provide more liquidity to the shadow banking sector, which has been hurt by the defaults of major financing company Infrastructure Leasing & Financial Services (IL&FS). Those defaults triggered a sell-off in bonds and stocks of non-banking financial companies. The government has been asking the RBI for a dedicated liquidity window for these lenders similar to one allowed during the 2008-09 global financial crisis.
- The government has also been urging the RBI to relax its lending restrictions on 11 state-run banks. The curbs were imposed because the banks had a low capital base and major bad debt problems. The 11 are barred from lending unless they reduce their bad debt levels, improve their capital ratios and become profitable. The government says the restrictions have gone too far and have reduced the availability of loans for small- and medium-sized businesses.
- The RBI is also irked by government efforts to trim the central bank’s regulatory powers by proposing to set up an independent payments regulator. Currently the RBI regulates all payments and settlements in the economy. The government says it wants a separate payment regulator which will be able to adapt to rapid changes in technology.
-The government appointed S. Gurumurthy, a prominent BJP supporter and figure in the Hindu nationalist Rashtriya Swayamsevak Sangh (RSS) group, to the RBI board earlier this year along with Satish Marathe, a former banker with ties to the RSS. Such political appointments have been unusual in the past as the RBI board’s external members have mostly been economists and industrialists. Traditionally, the RBI board has approved decisions related to internal functions of the central bank and has not interfered in its supervisory and monetary policy roles.
- Senior government officials, as well as BJP and RSS officials, were angry that the RBI decided to go public over the quarrels. Acharya had made it clear he had been asked to address the independence question by Patel and in a show of unity the three other deputy governors attended his speech. The government has stressed it would keep discussions with the RBI confidential.
But the government and board members feel that the RBI should be “more transparent and accountable” for its decisions, according to government sources.
WHY IT MATTERS
- The Modi government has been under pressure because of weak farm prices that have hurt rural incomes. There are also concerns that it is not creating enough jobs given the large number of young people entering the workforce every year.
Added to this, the IL&FS woes have led to a liquidity crunch across much of the shadow banking sector and throttled some lending.
All of this could slow the $2.6 trillion economy, the world’s sixth largest. To prevent that from happening, Modi is expected to spend more on populist programmes, including boosts to rural wages, and buying crops at a guaranteed minimum price.
- The spat has created political and economic uncertainty. Investors want policy continuity from both the RBI and the government to ensure inflation is kept in check and economic stability is maintained.
On the other hand, investors are concerned that anger in the countryside over low farm prices could lead to Modi being weakened at the next election, or even defeated. The resulting policy uncertainty, particularly if it involved a coalition government, would undermine confidence.
Reporting by Krishna N. Das; Editing by Martin Howell/Mark Heinrich
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