Special Feature     18-Dec-18
RBI Governor: Friend request
The task is to resolve the many issues causing rift between the Union government and the central bank
The Union government of India appointed Shaktikanta Das, a former revenue secretary, economic affairs secretary and current member of fifteenth Finance commission, as the 25th governor of the Reserve Bank of India (RBI) for three years within 24 hours of resignation of outgoing governor Urjit Patel. The new governor will have to deal with a number of contentious issues that persist between the central bank and the Central government. He will have a key task of restoring the credibility and maintain integrity and autonomy of the RBI.

As the economic affairs secretary, Das was the key man behind the planning and execution of demonetisation in November 2016. He also played an important role in rolling out of the goods and services tax. As revenue secretary, he worked closely with the finance minister and the empowered committee of state finance ministers to draw up the draft legislation.

Citing personal reasons, Patel unexpectedly resigned four days ahead of a meeting of the board of the central bank that could have discussed issues of differences with the government. The board is also scheduled to take up the issue of governance reforms that will give the Central government a bigger say in the RBI's decisions. He is the first governor since 1990 to step down before his term that was to end in September 2019.

Although Patel cited personal reasons for his resignation, it was open knowledge that there was rift between the central bank and the government on issues such as appropriate size of the RBI's balance sheet, proposal to use the balance sheet to recapitalize public sector banks, easing norms for banks under the Prompt Corrective Action (PCA) framework, liquidity for NBFCs and setting up of an independent regulator for payment systems outside the central bank. In the previous board meeting, the RBI ceded some control to proposed committees, with a decision on liquidity due later this month. 

The government's major demand is for a change in its economic capital framework. It wants more of the central bank's reserves to be transferred to it and the changed framework to come into effect in its term. The economic capital framework examines how the reserves will be treated and how much can be transferred to the government every year in addition to the dividend it pays. In the 19 November board meet, it was clear that the past reserves of the central bank would not be touched. It is now to be seen how the new governor takes forward RBI's agenda in the upcoming discussion.

The stricter PCA framework, with the lending activities of 11 public sector banks and one private sector bank under it being restricted, was a key cause of rift between the RBI and the government. Public sector banks under the PCA framework account for 18% of the banking system's credit and a significant 28% of the branch network. They comprised 35% of the banking sector's gross non-performing assets end September 2018. The finance ministry believed the action hurt credit growth and wanted some banks to exit from the PCA. In the last board meet, it was decided that the RBI's Board for Financial Supervision will take a call on the issue.

Non-bank financial companies (NBFCs) meet a significant part of the system's credit requirement. They are currently facing severe liquidity tightness, causing credit squeeze. The government is in favour of a special liquidity window for the NBFC sector. The central bank has resisted the proposal to boost liquidity and credit supply.

The RBI's February 12 circular has significantly tightened asset classification norms for the banking sector. The government wants to soften the strict one-day default norm, especially for loans to the power sector.

There is also a demand that the central bank softens its hawkish stance and let rates fall to give a fillip to growth, especially after reduction in its inflation projections for the second half of 2018-19. These are sharply within its comfort zone of 4% and are predicted to be below or around 4% in the next one year.

The new governor, who planned and implemented demonetisation, will be more comfortable to answer questions before a panel of MPs on various aspects of demonetisation including the counting of notes that returned to the system. Patel, in his capacity as og RBI governor, was due to appear before the panel.

A more immediate task for the new governor will be to address concerns of banks facing regulations that are excessively tough and tight liquidity hurting NBFCs. The government has been seeking relaxation of the PCA norms for PSU banks. The easing will be positive for banks under the PCA framework. The review of norms for promoter shareholding and the role of CEO will be relevant for Yes Bank, Kotak Mahindra Bank and Bandhan. The hike in maximum age of the CEO from 70 to 75 will benefit Indusind Bank and relaxation in the dual-listing norms Equitas Small Finance Bank, Ujjivan Small Finance Bank and most other small finance banks.

 

Conclusion

The equity as well as bond markets have welcomed the new governor's timely appointment with strong gains. It has revived the banking industry's expectation that there could be some relaxation of stricter rules. The governor is expected to be instrumental in easing the tensions between the RBI and the government.

The RBI might adopt a more neutral-to-dovish approach as inflation continues to undershoot the 4% target and growth rolls off its peak. It may shift to neutral stance as early as the February 2019 meeting, with the narrative increasingly swinging towards cuts if inflation stays below 4% and global oil shows little signs of revival. 

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