Modi -led Bharatiya Janata Party regime suffered its electoral triple strike in the Hindi-speaking heartland came the stunning announcement of the resignation of the Governor of the Reserve Bank of India, Urjit Patel. Tellingly, while Urjit Patel thanked his colleagues for their support in his parting statement issued to the media, nothing like that was reserved for either the officials of the Finance Ministry or the government in general. Obviously, Urjit Patel was leaving in a fit of pique. The inescapable conclusion on the timing was that even though Urjit Patel realised that his continuation at the helm had become impossible because of the mounting barrage of attacks on the independence of the institution, he could at least time his departure in a manner that would maximise its retributive impact.
The crisis highlighted yet again the utter inability of the Modi regime to work with any institution in the spirit of democratic cooperation and mutual respect that tolerated dissent. The impression that Modi seeks full-spectrum dominance of any relationship with Indian institutions has thus solidified after this exit of a top government functionary. Urjit Patel’s replacement, Shaktikanta Das, the former Union Finance Secretary who resolutely handled media queries in the aftermath of India’s adventure with demonetisation in November 2016 even as Urjit Patel, as the custodian of the national currency, remained impassive, reinforced the general consensus that Modi seeks to take control of the central bank in order to put it to use in the general election that is just months away. To get a sense of why Modi is so desperate to obtain this degree of control over a key Indian institution one needs to look at some of the apparently contentious issues between the government and the central bank in the recent past.
During the last year the Modi government has been increasingly hostile in its attitude to the RBI and its leadership. Initially, after the departure of Raghuram Rajan in August 2016, it appeared that the regime had settled into a more comfortable equation with Urjit Patel. In part, this was reinforced by Urjit Patel’s own conduct and pronouncements since the disastrous demonetisation of 86 per cent of the currency in circulation. This apparently congenial relationship on the surface papered over key differences on several issues, particularly because the central bank’s leadership feared that it was being pressured to cede control to the government in key areas of economic policy and regulatory control.
Chimera of autonomy
Since its founding in 1935, the RBI has been a full-service central bank. It is not merely a monetary authority but also a banking sector regulator, a protector of the banking sector by virtue of being the lender of last resort and a manager of foreign exchange reserves, the exchange rate, and national sovereign debt. All these are apart from its role as the sole issuer of the national currency and the regulator of the payment system.
It has been accepted that these wide-ranging functions and responsibilities require a degree of autonomy, although the extent of autonomy has been a subject of furious international debate in the last two decades. On one extreme are those arguing for a completely “rule-based” system in which the central bank is completely independent and only answerable to the markets, a system that is completely outside the pale of democratic control and accountability. One approximate example of such a system would be the Eurozone regime, which, in the case of Greece, for instance, imposed a completely “rule-based” solution that favoured private banks while beggaring the Greeks. At the other end of the spectrum, which is possibly what the Modi government is attempting to do, is the endeavour to make the central bank completely subservient to the diktats of the ruling regime. This kind of a central bank-government relationship can be termed as an arrangement that is aimed at fostering cronyism. In fact, Modi is only attempting to replicate what United States President Donald Trump did to Janet Yellen by not nominating her for a second term as Chair of the Federal Reserve System when her term ended earlier this year.
The battle between the RBI leadership and the government, centred on several issues, has festered for more than a year. On the question of monetary policy, Finance Minister Arun Jaitley and the political leadership have been insistent that the floor interest rates that the central bank sets be lowered, ostensibly to kick-start faltering economic activity, even if there is no evidence to show that “high” interest rates are responsible for the lack of investment in the Indian economy. The RBI leadership’s logic has been that the threat of inflation, most notably because of the high, and rising, cost of imported crude, poses risks that do not warrant a dovish monetary stance. But the conflict goes far beyond interest rates.
Raiding the reserves
One of the key elements in the dispute is the government’s insistence that the RBI part with its “substantial” reserves by transferring them to it. Although this was first suggested in the last Economic Survey, ostensibly to fund the recapitalisation of public sector banks (PSB), the fact is that once such a transfer takes place, there is, in practical terms, no restriction on what the government can do with such funds.
The government turned the screws on the RBI by even issuing thinly veiled suggestions through the media that it may take the unprecedented step of invoking Section 7 provisions of the RBI Act to force the central bank to part with its reserves. Section 7 empowers the government to “direct” the RBI to act in furtherance of what it deems to be “in public interest”. The “consultative process” on the matter of dilution of the RBI’s reserves, which is mandated by the Act preparatory to its actual invocation, was initiated by the government on October 10. In what appeared to be a ceasefire on the issue, it was decided that a committee would be appointed to determine the actual quantum of reserves the central bank would need to perform its functions.
Senior functionaries in the government have maintained that the reserves can be used to address what they claim is a tight liquidity condition. Implicit in this argument is the suggestion that the RBI has excess capital in its reserves. The logic of this claim is egregiously wrong, and for several reasons. First, what the quantum of reserves ought to be depends on a multitude of economic factors. These factors, in turn, depend on complex forecasting models which are completely outside the competence of the political leadership, particularly the one that is incumbent. For example, given the fact that one of the RBI’s key responsibilities is the management of the exchange rate and of national balance of payments, its reserves are the primary means of defending the national currency. This is not a merely hypothetical situation; in fact, as global crude oil prices mounted alarmingly recently, the RBI did intervene in the currency markets to defend the rupee by releasing dollars and making them available to the oil marketing companies.
Moreover, as Rakesh Mohan, the former Deputy Governor of the RBI, pointed out recently, the reserves are capital, which ensures an income stream in the future. In effect, a depletion of the reserves hurts its income-earning potential in the future. Drawing from the reserves is thus akin to a person selling his house to buy a shirt. In fact, the transfer of a portion of the reserves, which actually entails a diminution in the RBI’s holdings of government securities, is materially no different from a situation in which the central bank issues fresh government securities. In both cases, the long-term fiscal impact would be the same. The only difference of a government “raid” on the RBI reserves is that it creates an illusion of the government milking away resources for free. The Modi regime, fully aware that this makes no difference to the actual extent and nature of the fiscal deficit, is evidently more interested in what it can gain on a here-and-now basis with an eye on the general election. Such funds, if made over to the government, can provide it with the resources needed to throw sops to a sullen electorate that was in 2014 lured by the promise of acche din .
If the insistence on the transfer of “surplus” RBI reserves was preposterous, the shrill demand to roll back the stricter curbs introduced on banking activity, which were aimed at controlling the menace of bad loans, smacks of sheer hypocrisy. Truth be told, the cleaning up of the balance sheets of the PSBs was initiated during the tenure of Raghuram Rajan. In this, Arun Jaitley or others in the government had no quarrel with him or his successor because they were united by a common purpose.
Battle over prudential norms
The entire scheme to clean the balance sheet of banks was done with the key purpose of making them suitable for privatisation. After all, both RBI leaders and the government understood that the bad loan problem had to be addressed first before privatisation could even begin. To this end, an elaborate machinery was established, the main institutional arrangement of which was the Insolvency and Bankruptcy Code of 2016. This facilitated the sale of distressed assets, in which the lending banks have been victims, having suffered an average haircut of 50 per cent.
To put further pressure on the banks, the RBI initiated its Prompt Corrective Action (PCA) framework. Any bank that fails to adhere to the parameters prescribed by the RBI has to mandatorily invoke a PCA plan, which prescribes several restrictions depending on the extent and nature of the bank’s infraction of the PCA framework. Thus, banks may be prohibited from accessing high-cost deposits or there may be a curtailment of lending or of efforts to initiate a more aggressive drive to control NPAs. In effect, the PSBs’ ability to lend has been severely restricted as is evident from the anaemic growth of credit in the last two to three years.
There has been increasing pressure on the RBI leadership to loosen the PCA framework. Voices such as those of S. Gurumurthy, noted chartered accountant, Rashtriya Swayamsewak Sangh ideologue and convener of the Swadeshi Jagran Manch, who now sits on the RBI Board, have demanded that the PCA be loosened so that credit is made available more easily to small and medium enterprises. This insistence is not backed by a credible concern for small and medium enterprises that suffered the twin jolts of demonetisation and GST. The notion that these enterprises’ fundamental problem is access to credit is not only misplaced but dangerously wrong.
The continuing adverse impact of GST, for instance, which was reflected particularly in the urban and semi-urban areas in the recent round of elections, indicates how badly misplaced the issue of credit is. It is evident that the only motive for the Modi regime’s abandonment of “prudential” banking norms is to be able to deploy the PSBs in its service in the next round of elections.
Arun Jaitley and others within the government and business interests outside it have clamoured for an easing of the liquidity situation, especially for non-banking finance companies (NBFCs). But finance experts have long held the view that distinguishing between what is a liquidity crisis and what amounts to a crisis caused by insolvency is fraught with serious risks. They have pointed to the fact that there is currently no generalised liquidity crisis; instead, these are concentrated in a few pockets, which became noticeable after the recent collapse of the IL&FS.
A shortage of liquidity, by definition, is a temporary phenomenon, say, when an exporter makes a shipment and awaits payment. But if a business becomes insolvent but masquerades as one with a liquidity problem, there is the danger of the banking system actually fuelling a bubble that can cause bigger problems in the future. In effect, by misrepresenting an insolvency crisis as a liquidity crisis, the political leadership is pandering to the sectarian interests of a business elite at the expense of the banking system.
Cronyism versus consistency
But this was not just a quarrel over whether to pursue a populist option. Pursuant to its crackdown on the NPA crisis in banks, in February the RBI issued a circular that tightened the already stringent norms relating to such loans. A large number of power companies, among them the Tatas, Adani and Essar, were on the verge of insolvency as a result of the new guidelines. In fact, a significantly large proportion of national power generation capacity is now in the hands of companies that are deeply mired in debt; and they threaten the very existence of many of the PSBs.
The Modi government’s response was to direct the RBI to relax the guidelines on NPAs that it had issued; naturally, the RBI refused because it would amount to a loss of its credibility. It is clear that in this particular issue, while the regime batted for the truant companies, the RBI leadership valued more its credibility as a regulator.
The regime’s quarrel with the RBI leadership is also indicative of Modi’s style of functioning, which brooks no dissent. It is important to comprehend that on what ought to be the fate of Indian PSBs, Modi did not have any ideological differences with either Urjit Patel or Raghuram Rajan. But it appears that in Modi’s book of logic there are no permanent principles to be adhered to. It would appear that in his book, winning at all costs is a principle worthy in its own right. Modi’s peers are, apart from fellow politicians, the big business interests that he has so assiduously wooed during his tenure. For Urjit Patel or Raghuram Rajan their peers are fellow academics, a world which they would eventually return to in any case. In this realm, consistency—or at the very least, a logically stated and credible deviation from a previous position—is greatly valued by peers. It just would not do for them to favour cronyism while in office before going back to seek their peers’ respect. The ability to hold an independent line is a virtue, after all, in this world even if one is allowed to make a few compromises to political power now and then. Shaktikanta Das has no such baggage; he has no formal training in economics unlike his four predecessors who were doctorates in economics. His dogged defence of demonetisation seems to have been enough for him to qualify.
Modi has demonstrated his singular inability to tolerate a different opinion, let alone dissent. Urjit Patel’s exit, arguably forced, may well be Modi’s last, and desperate, throw of the dice as he approaches the Indian electorate with yet more promises and some more money to throw at them. The hand is well and truly in the national till as he prepares to promise more acche din .