[Editorial Analysis] An uneasy truce, but will it sustain

Mains Paper 3: Economic Development

Prelims level: RBI

Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment. Inclusive growth and issues arising from it

Context

• The Reserve Bank of India (RBI) signalled a truce on Monday after a marathon nine-hour board meeting, agreeing, among other things, to allow banks to boost lending to small businesses.

• The central bank also agreed to study a demand for transfer of its reserves to the government, although it didn’t concede to the demand.

• Most will agree that this is an uneasy truce with much of the friction that exists between the government and the central bank remaining unresolved.

Analysing the situation

• It is a welcome step that the two warring parties have stepped back from the brink and have agreed to find a middle ground.

• After days of open sparring and the government holding out a threat to invoke the never-used Section 7 of the RBI Act that gives the central bank’s board the power to take decisions in public interest, markets will heave a sigh of relief that the hostilities between the two arms of the government have ended, even if it’s temporary.

Comparing the situation with other countries

• Central banks everywhere, from Turkey to the US, are under increasing pressure from the governments.

• While central bankers say that they need to be free from pressures from the governments and lobby groups to focus on their job of containing inflation and maintaining financial stability.

• Their critics say that they are too secretive and have leaned in favour of big financial institutions over the interests of common citizens they are duty-bound to serve.

Steps taken by the government

• The regulator is best placed to decide how much capital buffers banks should maintain.

• The central bank did well to not bring down the capital adequacy ratio in line with bare minimum levels prescribed under Basel III norms.

• Instead, it has provided an extra year for banks to implement the capital to risk weighted asset ratio at 9%, giving the stressed public sector banks a breather.

• Although deferring the implementation of the norm by a year to 31 March, 2020, will not breach international norms.

• The RBI had originally intended to meet the norms a year in advance, Moody’s Investors Service on Tuesday termed the move as credit negative for the country’s state-run banks.

• This potentially increases the cost of borrowings for Indian banks, and highlights the perils of government tinkering with central bank functioning.

What RBI need to maintain?

• The RBI also seems to have held its ground on the contentious issue of opening the liquidity tap for non-banking financial companies (NBFCs).

• Instead, the central bank said it would inject ₹8,000 crore into the banking system through open market operations.

• This indicates that the government has failed to present convincing-enough data to persuade the RBI to address the liquidity shortage faced by NBFCs.

• The RBI made was to consider a scheme for restructuring of loans to micro, small and medium enterprises (MSMEs) with a maximum borrowing of ₹25 crore on the advice of its board.

• Although much depends on how the RBI implements this, the move may help alleviate the problems faced by thousands of small enterprises that were hit hard by demonetization in 2016 and the implementation of the goods and services tax the following year.

• The health of these small businesses is crucial for the government in an election year and may help thaw the frosty relationship between the two parties. India’s 65 million MSMEs employ as many as 120 million people.

Way forward

• While tension between the government and the central bank is inevitable with crucial elections due over the next six months.

• A healthy and functional relationship between the fiscal and monetary arms of the government is necessary to maintain India’s long-term economic growth and lift millions of its citizens out of poverty.

• As central banks the world over exercise powers that impact a wider section of society, politicians are more likely to intrude into their domain.

• Central banks have to work harder to maintain their independence.

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Prelims Questions:

Q.1) Consider the following statements about Non-Banking Financial Company (NBFC):

1. It cannot accept demand deposits.

2. It does not form part of the payment and
settlement system and cannot issue
cheques drawn on itself.

Which of the statements given above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Correct Answer: C

Mains Questions:

Q.1) The compromise between the government and the central bank is a good first step. Cortically analyse the statement.

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