Indian government and central bank fighting is bad for business

The tiff comes at a time when investor sentiment is already low amid loan defaults by a major Indian financial company IL&FS on more than $12 billion (Dh47.75bn) of its debt, a sharp fall in the stock markets and the rupee’s recent drop to a series of record lows.

A Reserve Bank of India (RBI) logo is seen at the gate of its office in New Delhi, India, November 9, 2018. REUTERS/Altaf Hussain
Powered by automated translation

An unprecedented public dispute between the Indian government and the central bank is showing no signs of abating, raising concerns about the negative effect it can have on the third-largest Asian economy and its potential to sour the investment climate in the country.

The government and the Reserve Bank of India have locked horns over issues including the bad loan crisis, the pressure on the exchequer to transfer reserves to the government and providing access to liquidity to non-banking financial companies, or shadow banks.

“This will impact the sentiment of the financial markets,” says Sujan Hajra, a former RBI economist of 13 years who is currently the chief economist and executive director at Anand Rathi, a financial services firm in Mumbai.

“It can impact both foreign and domestic investment because no investor wants uncertainty. The conflict has become rather unpleasant right now … quite a few issues have coincided and the back and forth arguments are growing.”

The tiff comes at a time when investor sentiment is already low amid loan defaults by a major Indian financial company IL&FS on more than $12 billion (Dh47.75bn) of its debt, a sharp fall in the stock markets and the rupee's recent drop to a series of record lows.

Growing problem
Growing problem

The public friction between the banking regulator and the government began in October, when the RBI's deputy governor Viral Acharya delivered a scathing speech in Mumbai, saying that undermining a central bank's autonomy could have "catastrophic" consequences. "Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution," he said at a lecture.

He also referred to “a thorny ongoing issue … of the rules for surplus transfer from the RBI to the government”.

A few days later, Finance Minister Arun Jaitley retorted, criticising the central bank for failing to control "indiscriminate lending" between 2008 and 2014, which has led to a bad loan crisis in India's banking sector – with combined bad debt topping more than $150bn, according to government figures.

State-backed lenders account for the lion’s share at of the total non-performing loans – about 86 per cent. New Delhi is eager for the RBI to ease lending restrictions that have been imposed on 11 state-controlled banks.

Arvind Narayanan, a banking executive in Mumbai, says that tensions between the RBI and the government are nothing new but the fact that this dispute has come out into the open is “not a healthy sign”.

"Short-term foreign portfolio investors look at such noise as an unwanted distraction to the already long list of negative factors – slowing growth, oil uncertainty, trade restrictions, rupee depreciation, US rate hikes, upcoming state elections and the bigger central [general] election in 2019," he says.

The RBI did not respond to a request for comment.

India's ministry of finance in an emailed statement to The National said the government's position is that "the autonomy for the central bank, within the framework of the RBI act, is an essential and accepted governance requirement".

“Both the government and the central bank, in their functioning, have to be guided by public interest and the requirements of the Indian economy,” it said, adding that “extensive consultations on several issues take place between the government and the RBI from time to time”.

But the disagreements between the authorities rumbled on in the public eye on Friday.

India's secretary of economic affairs Subhash Garg in a tweet said the government's "fiscal math is completely on track" and that there was "no proposal" for the RBI to transfer trillions of rupees to New Delhi, dismissing this as "misinformed speculation".


Read More:


The only proposal under discussion is to fix an appropriate economic capital framework for the RBI, which governs the exchequer’s capital requirements and in turn determines the surplus that can be transferred to the government, he adds.

The regulator and government frequently disagree over interest rates, with the latter’s stance generally being that rates should be cut to help make borrowing easier to boost the economy, while the RBI leans towards keeping rates elevated so it can fulfil one of its main functions, which is to keep inflation in check.

However, the current tussle goes beyond that.

"The limited independence enjoyed by the central bank is a grim reminder of the fact that the government continues to call the shots on crucial issues like the pace and quality of banking reforms," says Mahesh Singhi, the founder of Singhi Advisors, a global investment banking firm in Mumbai.

“The RBI does not have the independence and authority to overhaul an antiquated public banking system which is long overdue.”

RBI board is scheduled to meet on November 19, a gathering that is widely being described by the Indian media as a “day of reckoning”.

The issue has also become political, with former finance minister P Chidambaram from the opposition Congress party on Friday accusing the government of demanding large amounts of reserves from the central bank in order to boost spending because a general election is coming up in 2019.

“The core question that arises out of the rift between the RBI and the government is who will be held accountable if the RBI accedes to the policy demands of the government,” says Mr Singhi.

Speculation is rife in financial circles that central bank governor Urjit Patel may opt to resign during the next board meeting as the standoff with the government continues.

Opinion in India is divided with some siding with the regulator while others suggest that New Delhi is right to an extent, and RBI should ease restrictions to allow more lending for businesses to grow.

“At the moment it seems the government isn’t trying to control the RBI but force it to act … and worrying about the economic issues being faced by the country,” says Aditya Berlia, an executive board member of the Apeejay Stya and Svran Group, a family-run industrial and investment house in New Delhi.

“The breakdown in their communication is surprising and worrying for everyone.” 

The RBI, on the other hand, shouldn’t entirely be blamed for the challenges in the financial sector, however, it needs to “reform itself urgently”, he adds.

The situation is complicated by political motives beyond the demand for funds, Mr Berlia says.

“Given the rigid stance of the RBI with very conservative policy and tightening of credit by stopping banks from lending, the finance minister is right to be worried that the ruling party will be blamed for actions the RBI took especially with elections coming up,” he says.

“By criticising the RBI, he [the finance minister] is trying to distance the party from policy and actions the regulator has taken independently of the government.”

Mr Hajra says that matters such as the non-performing loan in the banking industry is a shared responsibility between the government and the central bank, with the RBI being the sector’s regulator, while the government is the major owner in India’s banking sector.

The tensions between the RBI and New Delhi have reached a point where a third party arbitration is perhaps needed to ease the situation, given both sides have their own agenda.

“My sense is that in the case of this kind of conflict, it’s better to form an independent committee of experts and let them take a call on which way is better,” says Mr Hajra.

Investors will be hoping that the matter does not escalate further, bankers say.

“Collaboration and trust between the parties is key,” says Mr Narayanan.

“In a pre-election year, such comments are not unusual. It’s important that these comments do not degenerate into unilateral and legislative actions. Any one party looking to dominate the other will lead to catastrophic outcomes.”

How the situation plays out over the coming days and weeks will be critical, he says.

“As long as the main characters take effort to build trust and work together, the industry will be comforted.”