With the MSME liquidity concerns addressed, it leaves almost no room for the government to shift the blame of a stressed economy on the shoulders of the RBI.
By Kalvakuntla Kavitha
The tussle between government and RBI, as discussed in my previous article in The Financial Express, owes much to a lack of policy design in dealing with disputes between the government and the central bank. In the Indian context, I had argued that the current deadlock between the RBI and government could only be broken if the RBI can have a way to buckle the NPAs in the public sector banks while at the same time making credit more accessible to farmers and small businesses. In this article I will discuss this issue of whether the RBI and the government are doing enough to spur growth in the micro, small and medium enterprises (MSME) sector and will also address the moot question of excess capital transfer from the apex bank to the government which forms a key part of the long-drawn struggle between the two.
Fortunately, in the nine-hour long RBI board meeting on the 19th of November, the central bank seems to have taken steps to ease lending for the MSMEs. It allowed banks to readjust loans up to Rs 25 crore given to the MSME sector. What this that essentially done is that it has diffused the government’s argument that the RBI is restricting liquidity to the MSME sector. The government had claimed that the apex bank’s Prompt Corrective Action (PCA) framework which put lending restrictions on banks, would restrict liquidity for the micro, small, and medium sized industries.
However, the RBI has given a clear signal indicating its commitment to infusing liquidity in the MSMEs and uncoupling the issue of MSME loans from the PCA framework restrictions which buckles banks with large NPAs from lending further to big businesses. With the MSME liquidity concerns addressed, it leaves almost no room for the government to shift the blame of a stressed economy on the shoulders of the RBI.
Currently, 11 of the 21 state run banks fall under the PCA framework with majority NPAs coming from large businesses and industries. As per a Financial Express report 12 companies constitute 25% of total NPAs. Further, the Minister of State Finance has admittedly mentioned in a Rajya Sabha question’s reply: 4,387 large borrowers account for Rs 8.6 lakh crore or 90 per cent of total non-performing assets (NPAs) of the banking sector at the end of March 2018. At the same time, as per the SME Chamber of Commerce, approximately 900,000 MSMEs have shut down over the last couple of years since demonetization in November 2016 and GST thereafter.
Now this is a point to ponder upon – on the one hand the government wants the PCA framework to be relaxed in ostensibly in the name of infusing liquidity in MSME sector, at the same time its own policies have impacted the MSME sector perhaps most adversely. The RBI is doing its best to inject liquidity into the MSME sector through relaxations as well as open market operations but if the government continues to make PCA a moot point, it clearly shows that the interest group being defended here by the latter is the big businesses and not the small enterprises.
While the PCA question has now been referred to a Board for Financial Supervision (BFS), another big question in the RBI and government stand-off remains to be resolved – that of RBI transferring its excess surplus to the government. Currently, Section 47 of the RBI Act enjoins the RBI to credit its annual surplus to the national exchequer, after provisions (as long as government maintains Rs 5 crore of reserve funds under Sec 46 of the Act).
This much contested issue has been referred to the Economic Capital Framework (ECF) board “the membership and terms of reference of which will be jointly determined by the Government of India and the RBI.” What this means is that there are high chances that the government will be able to manage some capital transfers to the exchequer from the apex bank. A recent Merryll Lynch analysis report has estimated that RBI will be asked to release anything between Rs 1 lakh crore and Rs 3 lakh crore to the exchequer.
While this could help the government alleviate some pressure from the economy amidst falling GST collections, it will negatively impact the fiscal deficit as the government will have to issue bonds to the RBI. It might give some respite to the government as it should be able to infuse some liquidity into the economy nearing the elections, it will nevertheless add to the long-term burden on the economy. The government has pegged fiscal deficit at 3.3% and this will in any case be a hard target to achieve.
External debt in India averaged $267.1 billion from 1999 until 2018, reaching an all-time high of $529.7 billion in the first quarter of 2018. As of the end of October 2018 the government has already used nearly 96% of borrowings and has little borrowing window left. However, in a situation wherein the external debt has increased and the capital coming in has not been invested in financially productive activities and sectors, it is only common sense that the nation may running headlong into an inflationary crisis.
Also, the weakening of the rupee exacerbates the problem as we will have to produce more to pay the same debt we had taken earlier this year. Therefore, in the bid to extract money from the RBI, the government may only temporarily address the problem of liquidity in the short run but will overall burden the economy in the medium to longer term. The hope is that considerations for the larger economic good prevail over temporary electoral concerns.
In the subsequent meetings, some of these moot points will be discussed between the government and the apex bank. While other issues such as that of the RBI’s decision to retain the capital to risk-weighted assets ratio (CRAR) at 9% – requiring banks to be more conservative in their lending – are likely to persist as areas of disagreements. It is to be seen as to how these deadlocks will be resolved in the short term. However, in the long run, learning from such episodes where fiscal policy becomes a zero-sum game between the government and the central bank, is imperative for policymakers. It should spur our country into thinking up robust policies, mechanisms, and even buffer institutions to contain and resolve such stalemates so that the economy can run without hitches.
Kalvakuntla Kavitha is a Member of the Parliament (Lok Sabha) from Nizamabad, Telangana.
The views expressed in this article are the author’s own.