Government-RBI spat: Detente in the cold war?

When Urjit Patel suddenly resigned as central bank governor on December 10, many expected the move to deepen the already sharp divide between the government and the Reserve Bank of India (RBI). But before the jittery markets could react, the government moved quickly and appointed former economic affairs secretary Shaktikanta Das as the new governor to quell any concerns. Still, the question is: Can the seasoned bureaucrat stabilise the rocky relationship between the RBI and the finance ministry?

Das certainly has his job cut out. To begin with, he will have a difficult task convincing investors of the independence and credibility of the central bank. After all, the general impression is that Patel quit to protect the credibility of the RBI after a protracted feud with the finance ministry over the autonomy of the institution.

Das, who is seen as a consensus builder, sought to dial down the tensions within hours of taking over. He told a news conference he would ensure the independence of the institution while keeping the government’s views on board. “I will ensure that it [the RBI’s autonomy] is intact. The RBI is a great institution… has a long and rich legacy,” he was quoted as saying. “Government is not just a stakeholder, but ...runs the economy and manages major policy decisions. So there has to be free, fair, objective and very frank discussions between the government and the RBI.” Though he was non-committal on specific plans, the bigger challenge is to resolve the contentious issues that have driven a wedge between the two arms of the government. Analysts expect Das to ease tensions because they see him as a finance ministry veteran who worked closely with the RBI when he oversaw the controversial demonetisation move in 2016. Analysts are also optimistic because of his open communication style, unlike his predecessor who was more reticent. There seems to be a thaw in tensions after a key December 14 RBI board meeting. Das appeared to take a rather conciliatory approach not just by ending the meeting in a few hours compared with the nine-hour marathon meeting on November 19. He also seemed to strike a balance on the issue of weak banks when he declared that four banks would come out of the prompt corrective action (PCA) framework.

Even so, he will be walking on fire and every step he takes will be watched carefully, especially in relation to lending curbs and the use of the RBI’s surplus reserves. Some of the immediate challenges are finding a successor to replace Rana Kapoor of YES Bank, dealing with loss making power producers demanding the dilution of the February 12 circular on the definition of defaulters, and finding members to examine the economic capital framework to decide whether the RBI’s surplus reserves are too high.

It won’t be easy. The days when differences over policy matters on growth, inflation and financial stability were resolved in private— within the four walls of North Block or the RBI headquarters on Mint Street—are over. Spats between the government and the RBI had rarely been so acrimonious and public that a central bank governor had been forced to resign. That is, until now. Patel quit suddenly citing personal reasons, but it was clear his shock resignation was a result of the face-off with the government. Things went from bad to worse in the past few years, as the economy started to slow and the twin blows of demonetisation and the poorly implemented goods and services tax (GST), along with high crude oil prices, started to bite.

While the government pushed for growth and employment at all costs, the central bank wanted to temper growth with financial stability, especially in a pre-election year. After all, inflation targeting remains its primary objective. It was only a matter of time before the differences burst out in the open. The government started treading on the RBI’s policy-making turf and asking it, among other things, to open up a liquidity window for small, medium and micro industries adversely impacted by demonetisation and non-banking financial institutions hit by a cash crunch as a fallout of the IL&FS fiasco. The issue of infusing sector-specific liquidity has been a bone of contention between the RBI and the government with the central bank refusing to toe the government line, forcefully arguing that there is ample liquidity in the system.

Again, the government’s call to return the “excess reserves” lying in the RBI’s coffers for more productive purposes has fallen on deaf ears. The RBI has argued that it requires the reserves to conduct its monetary policy objectives like protecting the rupee from extreme volatility, managing foreign exchange reserves and being the lender of last resort. It has also held that allowing stressed state-run banks, or those under the PCA framework, to lend would hurt the RBI’s move to repair their balance sheets, and add to the mounting non-performing assets.

Tensions between the institutions, already at loggerheads, had grown after the government appointed allies to the RBI board to turn the heat on the central bank. The board became more aggressive and there was talk of invoking Section 7 of the RBI Act of 1934, which allows the government to dictate policy issues to the central bank. The November 19 meeting had raised hopes but tensions continued to simmer. Now the question is: Is the spat between them finally over?