Urjit Patel’s resignation shows up the govt in a poor light, of one unwilling to accept an independent RBI Governor
Given how US president Donald Trump openly criticizes the Fed and how Japanese prime minister Shinzo Abe got the Bank of Japan to fall in line when he came to power, it would be incorrect to argue that the Government of India and the RBI’s very public fight is something that only happens in developing countries; the world over, there is a greater assertion by elected governments. And with Patel not the only RBI Governor to resign, it is unfair to say that this happened only under the BJP.
What makes things different is that, with Urjit Patel resigning as RBI Governor – and more resignations can’t be ruled out – in the face of a continuous onslaught by the government, investors are going to be worried; the fact that this signals the government is uncomfortable with independent-minded regulators only adds to the problem. If the markets read Patel’s resignation as evidence of the fact that part of the central bank’s reserves will be taken away by the government – and if it is done once, it can be done again – investors may start pulling out money, at least till the government takes measures to reassure them of its intentions. Sequestering part of RBI’s reserves, for instance, could send also negative signals about the RBI’s ability to defend the rupee – one of the points made by RBI to defend its high reserves was that, at a time when India didn’t have a AAA rating, the central bank needed to have one.
There was nothing wrong with the government of India arguing that the RBI had excessive reserves; indeed, the first person to argue this was former chief economic advisor Arvind Subramanian, and he was never regarded as someone who toed the government line. What was problematic, however, was the government trying to resolve this issue at virtually gunpoint – by asking RBI to discuss this under Section 7 which allows it to issue a directive that RBI simply has to follow – instead of weighing the pros and cons carefully and inviting top-notch economists and central bankers to weigh in on the issue. If Subramanian had argued for the reserves being excessive, after all, former RBI Governor Raghuram Rajan had argued that they were required. Given how Patel had blotted his copy book by recommending demonetisation – without this, there could have been no demonetisation – he was understandably reluctant to be seen as a rubber stamp again.
There can be little doubt, as this newspaper has argued before, that RBI has been slow to cut repo rates or to increase liquidity. But this happened even before Patel became the Governor; indeed, by moving to a Monetary Policy Committee with an inflation-target and appointing most of its members, the government had, in any case, ensured the Governor was no longer as all-powerful as before.
Apart from trying to force RBI to blink on the issue of its capital, the government was also trying to muscle in on other functions of an independent central bank – the fact that finance minister Arun Jaitley repeatedly said that, unlike regulators, only politicians were truly accountable to people has also reinforced the view that the government would like a less independent central bank. In fact, as Economic Affairs secretary Subhash Garg made clear in an interview to this newspaper, the government was going to try to ensure the RBI’s board – appointed by the government – played a larger role in how the central bank was to be run.
What is worse, apart from compromising the independence of RBI, what the government was asking for was bad economics and policy. Under previous governments, various PSU banks had lent recklessly and, by invoking its PCA regulations that curbed their lending, RBI was ensuring taxpayers didn’t have to foot a larger bailout bill as the banks had eroded their capital – ironically, RBI keeping quiet when reckless lending took place in the past was something Jaitley brought up as criticism.
In the case of the power sector, where the government wanted RBI to relax its NPA rules, as this newspaper has pointed out (https://goo.gl/1mmPDD), it was government policy that was responsible for the mess, so asking RBI to fix this was unfair, apart from not being possible. The move would also weaken the Insolvency and Bankruptcy Code (IBC) since others would also demand the same treatment – ironically, IBC is one of the government’s big reforms. Ditto for the telecom sector where the next set of big NPAs is going to emerge from. In the case of MSMEs where RBI was being blamed for a lending squeeze, it was disingenuous to ignore the role of demonetization and GST – and also RERA in the case of the real estate sector – in hurting these sectors.
RBI was certainly slow on recognizing bad loans before the BJP came to power, though one view – uncorroborated, though – is that RBI went slow on this because the government didn’t have enough money to recapitalize banks. But even if RBI was to blame, the government equally culpable since it owned the banks that did the dodgy lending and which were ever-greening loans. If RBI to blame for not spotting IL&FS mess, as it most certainly was, so was the Financial Stability and Development Council that is chaired by the finance minister and has many finance ministry bureaucrats; more important, IL&FS had SBI, LIC and Central Bank of India as shareholders.
While the government seems to have overplayed its hand at RBI, the markets will now wait to see who the next RBI Governor will be and what moves are made to restore the confidence of markets; if the next Governor is seen as someone who will surrender capital, relax PCA norms, allow power loans to not be classified as NPAs, this will ensure the markets remain nervous. Pity all this has happened just as, with oil prices softening and the rupee strengthening, India’s macros looked like they were turning around, and the stage was set for a rate cut two months from now. Markets will watch both this and the signals from the assembly results over the next few days.