Conflict between the Government and the RBI


                  Conflict between the Government and the RBI

 Autonomy of RBI

The word ‘autonomous’ does not occur in the RBI Act 1934. But, over the years, the principle of Central Bank autonomy has been raised to the level of an unassailable law.
Under Section 7 of the Act, the Central government may give such directions to the RBI as it may consider necessary in the public interest, but the power has never been exercised in the 84 years of the Act.
There have been times when the RBI and the Central government did not see eye-to-eye. The first Indian RBI governor – C.D. Deshmukh - had differences with the government over the nationalisation of the central bank. He wanted to keep the RBI private and out of reach of the central government o Second Indian RBI governor, Sir Benegal Rama Rau resigned in 1957 over his differences with the then finance minister (T.T. Krishnamachari).
Overall, however, the RBI and the Central government respected each other’s jurisdiction and learnt to work with each other. In a closed economy and with little reserves, the RBI was known more as a banking regulator and tight-fisted controller of foreign exchange than as an issuer of bank notes.
Since November 8, 2016, of course, the role of the RBI as the issuer of bank notes has come into prominence.
The RBI has the sole right to issue bank notes (Section 22). The RBI shall recommend the denominational values of the notes as well as the discontinuance of issue of notes (Section 24). Further, it is on the recommendation of the RBI that the Central government may declare that any series of bank notes shall cease to be legal tender (Section 26).

Sticking points between the Government and the RBI
The conflict between the Modi government and the Central Bank revolves around three axes – (a) Who controls the monetary policy (primarily interest rates);  (b) the issue of regulation of the non-performing assets – extension of the first axis of conflict; and  (c) who controls the boards and the appointments of people who will formulate monetary policy.
(1) RBI is of the opinion that it does not have sufficient powers to regulate the PSBs (which the Govt doesn’t accept). This was very evident in the public spat when the government criticised RBI for not detecting the Nirav Modi scam, to which RBI shot back saying it needs more powers to regulate the PSBs in areas such as  Removing the chiefs of the banks
(2) RBI is sitting on a huge value of reserves. The government has made repeated calls for the Reserve Bank to hand over more money from the RBI's reserves to help fund its fiscal deficit. The RBI currently hands over its profits earned from various activities in the form of a dividend. But the government also wants to tap a share of the RBI's Rs 3.6 lakh crore ($48.73  billion) of capital reserves. The RBI has consistently pushed back against the demand. 
(3) The government wants to set up a payment regulator which has been opposed by the central banker. 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.
(4) The February 12, 2018 circular issued by RBI which redefined NPAs and revised the framework for the resolution (For loans above ₹ 2000 Cr non-repayment/default by a day will trigger a process and these will have be resolved within 180 days from the day of default. If not these have to be taken to Insolvency and Bankruptcy Code, 2016 ).
(5) In 2017, government ventured into RBI territory. It directed banks to increase the cash credit limit for MSMEs from 20 per cent to 30 per cent. It directed banks to provide 8 per cent interest on 10-year fixed deposits of senior citizens.
The RBI has come under severe criticism both within India and abroad. It was feared that the RBI may fall victim to ‘institutional capture’ by the current regime and jeopardize its long nurtured autonomy.
 (6) Government is unhappy with some of the regulatory measures such as PCA of the central bank. Prompt Corrective Action (PCA) is taken by RBI on 11 PSBs, These PSBs cannot lend to private sectors. Govt. is not happy because it leads to liquidity crunch while money is laid idle. Because of low liquidity in market development is obstructed. RBI said give bailout package. The government says the restrictions have gone too far and have reduced the availability of loans for small- and medium sized businesses.
(7) Inflation control – Govt wants more liquidity in the market, but RBI has to maintain inflation within 2-6% range. 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). 
(8)  Allocation of surplus profits by RBI to Govt. (S.47 of RBI Act):
The government wants more surplus; the RBI wants to make more reserves from profits for unforeseen risks, thus leading to lesser surplus transfer.
The central bank, which follows July-June financial year. In its 83-year-long history, the RBI transferred highest ever surplus in the year 2014-15, which was Rs 65,896 crore. However, in the year 2016-17, the RBI surplus transfer dropped to just Rs  30,659 crore against the budgeted amount of Rs 58,000 crore, which, economists argue, was due to the higher printing cost post demonetisation.
(8) Use of S.7 of the RBI Act: Under Section 7, “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest. Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a Central Board of Directors which may exercise all powers and do all acts and things which may be exercised or done by the Bank.”
Now, the government has started the process, or the first step towards invoking those powers under Section 7 — which is to start consultations with the RBI Governor on issues such as easing the PCA framework, providing more credit to small units. The next step would be to issue a directive to the RBI. Since the clause was never invoked in the past, there were various ways to interpret it.
(9) Control over RBI Board : The government appointed S Gurumurthy, an ideologue of the Rashtriya Swayamsevak Sangh (RSS), 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's board has approved decisions related to internal functions of the central bank and it has not interfered in its supervisory and monetary policy functions.
(10) Government is unhappy that the RBI decided to go public over the quarrels. RBI deputy governor, Viral Acharya, on October 27, 2018 warned against encroaching on RBI autonomy. Next day, the finance ministry chose to respond publicly, when finance minister accused RBI of sleeping on the job when public sector banks were nudged by politicians to lend indiscriminately between 2008 and 2014. 

Related Terms
(1) Shadow Banking Sector: The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations.
(2)  Allocation of Surplus Profits:  Every year the central bank transfers the balance of its profits to its owner, the government, as per the RBI Act, after making provisions for bad or doubtful debts, contribution to staff, depreciation of assets and superannuation funds.
There’s no fixed benchmark for the transfer of this surplus profits. Before every union budget, the government and the RBI discuss the surplus amount. The government, then, puts its surplus expectations in the budget, while the RBI announces the actual amount in August after making the calculation.
In words of former governor Raghuram Rajan, the RBI prints the currency notes held by the people, and issues deposits to commercial banks. Those are fixed liabilities for which the RBI does not pay any interest. However, as the central bank issues these liabilities, it also buys financial assets, in forms of domestic and foreign government bonds, from the market. Now, these assets get RBI interest. So RBI generates a large net interest income simply because we pay nothing on virtually all our liabilities.
The total cost of printing the currency, according to Rajan, is 1/7th of the total net interest income. Besides transferring a part of surplus profits, the RBI also has another task at hand: maintaining an international AAA rating so that its credibility in the market is intact.
(3) Cash Credit Limit
Cash credit is a short-term source of finance. Under cash credit, the bank offers its customer to take a loan up to a certain limit. Cash credit is also known as bank overdraft.
This loan is given to meet the working capital requirements of a company.  It is given against a collateral security. Interest is charged only on the amount of loan taken by the customer and not on the amount of credit sanctioned.
Cash credit can be obtained very easily and quickly. Interest is charged only on the utilized amount. The rate of interest charged by loan on cash credit is very high.
Such loan is granted by bank on the basis of company’s turnover, its financial status, value of inven­tory, etc. So it is difficult for new and financially weak companies to obtain cash credit.
For banks, cash credit disturbs their credit planning.

Friday, 09th Nov 2018, 02:20:42 PM

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