From the CBI to the RBI, the Modi government is losing the plot

Reserve Bank of India Deputy Governor, Viral Acharya’s AD Shroff Memorial Lecture in Mumbai on October 26, was quite daring. The choice of quotes and analogy was revealing. Acharya was referring to the statement made at a news conference by Argentina’s central bank chief, Martin Redrado, after his resignation in January 2010. The trigger for that event was the Argentine government’s emergency decree to use the central bank’s reserves to pay its debt. Redrado felt that the reserves were needed for emergencies and transferring them to a government which exercised little control on its expenditure would make inflation worse and undermine the economy.

Acharya’s lecture was on the importance of independent regulatory institutions, particularly central banks. It was not a theme suggested by the organizers. Acharya said he ‘chose’ it. He added that Reserve Bank Governor Urjit Patel had also suggested that he “explore” the theme. It was a not-so-veiled message to the government to desist from further eroding the autonomy of the Reserve Bank.

The Reserve Bank has been chafing at pressure from the finance ministry to transfer its ‘excess’ reserves to the government for capital infusion in public sector banks that have been knocked down by bad debts. In the 2015-16 Economic Survey, Arvind Subramanian, the Chief Economic Adviser, had made a case for such a transfer. There are differences between the two on how large the contingency reserves should be. In 2013-14, 2014-15 and 2015-16, the Reserve Bank transferred 99.9% of its surpluses to the government, a big jump from the previous two years. But last year its transfer was half that of the previous year because of a sharp rise in provisions and the extra expenditure on printing currency notes to replace those that were demonetized.

The government has been struggling to keep its fiscal deficit under control because global factors have turned adverse. Interest rates are rising in the United States. Foreign institutional investors have been selling Indian debt and stocks to invest in safer US bonds. That has weakened the rupee. Alongside, crude oil prices have risen. The combination of the two has swelled India’s import bill and boosted domestic fuel prices. Domestic interest rates have also hardened. Rising interest payments and higher fuel and fertilizer subsidies are expanding the size of the government’s expenditure. The fiscal deficit has crossed 95% of the budget target in the first six months of this financial year. The Reserve Bank, which has a mandate to keep consumer price inflation at around 4%, is not being as accommodative with money as the government wishes it to be.

The crisis in Infrastructure Leasing & Financial Services, a large non-banking financial institution which also executed projects, has aggravated the government’s misery. It has defaulted on its debt, prompting the government to take over its management. Banks have become wary of lending to non-banking financial companies (NBFCs) and housing finance companies (HFCs). Many of them have exposure to IL&FS’s debt. They do not want to be saddled with more bad loans. But NBFCs are leaders in retail lending. Small and medium enterprises (SME) also borrow from them. The crimping of credit is creating disaffection among a sizeable section of voters ahead of the assembly elections.

The Reserve Bank has been resisting government nominees on its board to relax the lending norms to NBFCs and to be slow in invoking the bankruptcy code against defaulting power producers. Unwilling to countenance the push back, the government has been thinking of overruling the RBI using an emergency provision. .

The Reserve Bank’s credibility has been dented by the blunder of demonetization, which seems to have been done without consulting it. The bad loan mess, which is most pronounced in public sector banks, also speaks poorly of its supervision. Finance Minister Arun Jaitley rubbed this in at the meeting of the Financial Stability and Development Council (FSDC) meeting on Monday. In his speech Acharya had explained why the Reserve Bank was not as effective in dealing with weak public sector banks as it is with private ones.

Acharya also spoke of the role of the rule of law and accountable governments “in creating stable, peaceful, prosperous, inclusive and honest societies”.

Buzz about the Reserve Bank Governor resigning and the markets taking a hit in case of drastic action seems to have constrained the government. It has issued a bland statement about respecting the autonomy of the Reserve Bank.

From not recognizing the leader of the largest opposition party as Leader of the Opposition, not establishing a Lok Pal, passing pieces of legislation as money bills to bypass the Rajya Sabha where the ruling coalition lacks a majority, second-guessing appointments to the Supreme Court to undermining the Central Bureau of Investigation, this government has played fast and loose with institutions. When Modi kissed the steps of Parliament on 20 May, 2014 after leading his party to emphatic victory in the Lok Sabha elections, one did not think he meant to kiss goodbye to democratic norms and practices.