Modi versus RBI
The tussle between Modi & RBI came into the open when Viral Acharya, Deputy Governor of the RBI, in a public forum, warned the government against curbing the independence of the RBI. Differences between RBI and governments are normal in democracies & have been there in India in the past as well. This recent public sparring is new. With Modi threatening invocation of Article 7 & Patel threatening resignation, Modi has temporarily blinked. With a bruised Patel winning the round one Modi as well as India are losing. I have analyzed the tussle to explain the problem and suggest remedies.
RELEVANT BACKGROUND FACTORS TO UNDERSTAND THE PROBLEM
General Pressures on Modi/ Government
- The possibility of losing the coming state elections and 2019 Lok Sabha election.
- Public opinion that demonetization was stupid and GST implemented badly.
- Increasing public perception that Modi/ BJP are corrupt and favour big & corrupt businessmen.
- Rural population and farmers are unhappy with the government.
- Small & medium industries were ruined by demonetization. This fact is adversely affecting growth & employment generation today & is also likely to adversely impact Modi’s election.
- Rajan, the former RBI Governor had given a list of high profile frauds worth Rs 17,500 crore to Modi in Apr 2015. No action has been taken by Modi on this till date. A quote from “The Wire” report says,” For instance large power projects, with Rs 3 lakh crore of bad loans, promoted by politically powerful business houses desperately want to avoid going to the bankruptcy courts”. It is my conjecture that these corporates will be the biggest source of election funds for Modi & hence he will not act against them.
Circumstances of Patel’s Appointment as Governor
Rajan was not a Modi appointee and has great international standing. He not only exercised independence but pushed the boundaries of autonomy by giving unsolicited advice to Modi on curbing religious intolerance (for details read the references given). When asked to comment on India being the bright spot in a dim world economy, he, rather than praising Modi, made the famous statement of comparing India to “one eyed man among the blind”. Replacement of Rajan by Patel made the latter appear like a Modi stooge. This perception got reinforced when he mutely shared the responsibility of demonetization. I can imagine the discomfort he would have felt through answering tough questions to the JPC and by heading an institution whose autonomy was eroded under his nose.
Pressure on Patel/RBI
- After facing a rebellion from the 4 judges, Dipak Misra had shown good backbone in his later tenure as the CJI. Patel, too, probably decided that he may not be a Rajan but he will prove to the RBI, India and the world that he is no stooge either.
- He has been asserting RBI’s autonomy in the MPC meetings post taking the demonetization egg on his face.
- Patel has to safe guard the reputation of the RBI as also his own. He is doing that now.
- Modi is continuously striving to erode all institutions, including the RBI, with the appointment of RSS guys in the RBI board.
Urgent Economic Pressures on Modi/Government
- Poor revenue collection of the government.
- Government’s rising current account deficit (CAD) owing to rising oil prices.
- The loss of government’s revenue through oil subsidy and requirement of subsidy to farmers.
- Likelihood of the government’s failure to meet the fiscal deficit target & consequent adverse impact on inflation, value of the Rupee, international standing and foreign trade.
- Over Rs 10 lac crore of NPAs with the banking sector.
- The crisis of cash with IL&FS as also NBFCs, which apart from being an economic crisis is also having an adverse impact on growth.
- The restriction imposed on 11 banks by the RBI.
MAJOR ISSUES OF CURRENT RIFT
- Interest Rates: Like all governments, Modi government wants to lower interest rates but RBI is focused on inflation targeting. This is usual as government’s focus is the coming elections and RBI has a long term perspective.
- Nirav Modi Scam: Jaitley shifted blame on RBI for Nirav Modi scam for inadequate supervision. Patel sought more powers to oversee public sector banks. The fact is that the government was far more blameworthy or complicit in the scam than RBI.
- NBFCs: The government wants relief to non-banking financial companies (NBFCs) which are grappling with cash crunch after IL&FS default on payments of over Rs 90,000 crore. RBI is not accepting government’s advice. This issue must be quickly resolved because it affects growth and market sentiments. My view is that the RBI should soften its stance but lending should be done only after due diligence.
- Higher Dividend Demand: To control the fiscal deficit the government wants higher dividend from the RBI. In my view a compromise figure should be reached between Jaitley and Patel, with Patel being less rigid.
- Diluting PCA framework: Under the ‘prompt corrective action’ (PCA) framework, a set of rules that central bank applies for weaker banks that have serious or structural problems, 11 state-owned lenders are under restrictions placed by the PCA framework. When under PCA, a bank is required to increase provisioning for NPAs and have restrictions on giving fresh loans. The government obviously wants dilution of the framework because it affects the public at large because major sources of credit have dried up. This is the action RBI is taking to prevent increase in the NPAs. RBI expects the government to infuse the required funds to tide over the problem. This issue should also be resolved earliest in a spirit of give and take.
- Rs 3 lac Crore NPAs of Politically Connected Power Sector Corporates: The government wants special handling of the NPAs of the power sector. After power companies took the issues to the court, Modi threatened the use of Section 7 of the RBI Act. This never used section allows the Indian government to give directions to the central bank “in public interest”. RBI is not agreeing to treat power sector companies as special and Patel has threatened resignation in case of invocation of Section 7.
My Final Take on the Issue
As regards interest rates MPC should do its job uninfluenced by the government. On the higher dividend demand, NBFCs and PCAs framework Patel should reduce his rigid stance and resolve the issues in the spirit of give and take. I agree with Patel in calling Modi’s bluff on the threat of using Article 7 as regards the Rs 3 lac crore power sector NPAs in which there is apparently fraud involved. Modi does not have the guts to use Article 7 because he will then further get exposed.
Early resolution of the differences is in the interest of India. Both Patel & Modi should understand that and act accordingly.