Is the RBI autonomy in peril?

D M Deshpande

Much of the public spat between the RBI and the Ministry of Finance could have been avoided. Needlessly, it has raised temperatures on both the sides. As a result, real issues that need to be resolved amicably are  getting blurred. So far, markets have not been affected significantly. But if both sides try to pull the economy in opposite directions, markets will get hit. Similar is the case with investments-both Indian and foreign.

A lot of confusion may also have arisen due to the fact that no one is clear as to what is really expected of the Apex Bank. Of late, it has become more of a inflation targeting entity. This, of course, is in keeping with global trends. Perhaps, the Government feels that it is not paying adequate attention to the issue of liquidity in the economy. Several NBFC’s have been hit in recent times starting from the sordid saga of IL&FS. While the Government could be sympathetic to them, it seems to be overdoing the liquidity issue.

NBFC’s had a good going for quite some time; their equities have risen far too quickly in some cases. They have borrowed cheap short term funds from commercial banks and used them for long term lending at higher margins. Banks’ lending to them have shot up by 41% in this year till September. While bank stocks have plunged, well at least stagnated, those of NBFC’s have risen quite sharply. Now, if they are required to borrow at a rate slightly higher than repo, so be it.

This is, however, not to suggest that the Government cannot raise legitimate liquidity issue with the RBI. It is pertinent to note that the M3 (broad money) growth has plunged from 14% in 2014 to less than 10% now. A significant drop after demonetization and now as digital payments are picking up, cash requirement is progressively getting reduced. Capital inflows too have declined this year owing to external factors such as the Fed increasing the rates. Simultaneously, the RBI’s U.S treasury holding too have gone up.

There are three ways in which liquidity could be infused or expanded in the economy. One is to increase the money supply M3, which if the Government spends on non-productive assets is certain to fuel inflation and therefore is not largely recommended. Second, use the option to reduce holdings in treasury bills or raise money from abroad by issuing bonds and third, reduce or soften the provisioning norms temporarily so that banks which have liquidity can lend a bit more freely. This does not mean some borrowers are let off the hook. Banks shall continue to make all those efforts to recover their NPA’s, as usual. Due to fiscal constraints, the centre may not be in a position to recapitalise the banks now. Yet it is seeking a way out of addressing the liquidity problem.

Going by press reports, the Government is eyeing around Rs.3.6 lakh Crores lying with the RBI. This has become a bone of contention between the two. The Government feels that the reserves are excessive, which was made clear in the 2016 economic survey. Excessive, in relation to some other central banks and therefore the RBI could part with some of that amount. Noted economists are of the view that the amount or extent of reserves should be specific to an economy and the mandate given to the central bank.

The RBI is a full fledged service bank and is mandated to serve and achieve, very often, conflicting objectives. Even while rate of inflation is within limits, it has to ensure that the GDP growth is not hampered. Indian rupee is a managed ‘float’ not a free float. So, the RBI has to keep a watchful eye on exchange price movements and intervene in times of violent fluctuations. And to do that, it needs to have sufficient forex reserves. It is not always useful to compare with the Federal Reserve which has a bloated balance sheet post financial crisis. The US has had an extraordinary monetary policy since 2009.

It is also possible to argue that the RBI may part with some of its reserves now and when in crisis, fall back on the government. However, there is no guarantee that the government too would not be in crisis at that time! Differences between the RBI and the government do exist and in fact, it is a healthy sign. Successful democracies work through the institutions. The debate that elected ones are superior to unelected institutions is meaningless. Both sides could agree to form a committee of experts to suggest whether and if a part of the reserves could be given to the Government. The Committee could also be asked to suggest where these monies could be deployed for example, in recapitalizing the public sector banks. What is of utmost importance is that India and its economy should move on.