RBI vs GOI — The Flip Side
The resignation of Urjit Patel — Governor, Reserve Bank of India, comes as a surprise given there was an attempt to iron out the differences between GOI and RBI barely a few weeks back [1]. But, what comes as a bigger surprise is how could the government have let this happen, given the weak position they are in politically. And, this news would give the opposition enough juice, to question the intent of the ruling party and shake the confidence of citizens and investors in the way the government is functioning.
We all would agree that Finance Minister Arun Jaitley and Prime Minister Narendra Modi, are smart enough to have gauged the political impact of this move by the RBI Governor, and would have let the issue simmer at least till the next general election (hardly a few months away), to avoid a political catastrophe. But that did not happen, and here we are today!
While we can only speculate what could have transcribed between the Government and RBI. But let’s try to understand the rationale behind Government’s demands, which led to this situation, and gauge for ourselves if there was any merit in the Government’s ask.
Access to RBI’s forex reserves:
India has come a long way in terms of its Forex reserves. Increasing it from a meager $3.6 Billion in 1990 to the current levels of $400 Billion [2]. Approximately $100 Billion of which was raised after May 2014, when the current government came into power, as a part of their successful push to attract foreign investors into the country.
Now, talking in layman’s terms this is how the RBI’s forex reserves increased in the process — FII (Foreign Institutional Investors) bring in foreign currency as investments to India. Since the medium of exchange within India is ‘Indian Rupee (INR)’, the Reserve bank keeps the foreign currency (adding to its Foreign Reserves) and issues Indian Rupee in exchange to the investor, thereby strengthening the Rupee. Now here is the interesting part, when the FII withdraws the investment from India, the Reserve Bank does not pay them back from the reserves which they collected, but lets the market forces account for the demand of dollar. This weakens the Rupee and the value of Rupee goes down as compared to the foreign currency (dollar), due to the demand-supply gap.
In the current global scenario, where there is high economic uncertainty due to the ongoing trade wars between the USA and China, uncertain crude oil prices due to the sanctions on Iran, and because of other global and domestic issues (upcoming general elections etc.), foreign investors are wary of its impact on the emerging markets (India) and are booking profits on the investments they made. This is causing the Rupee to plunge to the levels it is on currently. A rapidly falling Rupee causes more panic and in order to prevent further losses (due to the unfavorable Rupee-Dollar conversion rates), foreign investors sell their positions even further, causing a greater fall in the value of Rupee.
Ideally, in such a situation, the Reserve Bank intervenes to prevent further weakening of the home currency by selling dollars (from their foreign reserves), to change the negative sentiment. Unfortunately, even in these testing times for India, the RBI has shieded away from their responsibility and has not taken any steps to prevent further fall in Rupee, thereby increasing the negative sentiment around the currency. This while helps the exports, severely affects the import and since India is primarily an importer, gives a serious blow to our economy, causing a trade deficit.
While, I by no mean am in favor of tapping into the Forex reserves all the time in order to boost short-term growth, at the expense of long-term sustainability, but India is in a unique position right now, where the current government is inking deals with foreign partners to trade in the local currency. We are already buying oil from Iran in Indian Rupee [3] and have even signed a pact with UAE to trade in our local currencies [4]. The inactivity on RBI’s part to reverse the falling Rupee is a huge blow to the current Government’s initiatives to end its dependence on the US Dollar and make INR a truly global currency. After all which country would want to trade in a currency whose value is in a state of free fall?
Given the current scenario, some kind of intervention from RBI, by conservatively letting the Government use the Forex reserves in extremely small amounts to prevent Rupee from falling further, or by introducing something like a Tobin Tax [5], to stabilize the Rupee, would have helped in the long-term growth of the country.
But unfortunately, egos came in between, RBI called it an intrusion into their autonomy, and what should have been solved amicably for the larger good of the country will now reduce to a circus in the political corridors.
The NPA Problem in PSUs, affecting lending activities:
The problem of colossal NPAs mounted by the Public Sector Banks is another area of contention between the Government and the RBI. While each passed the responsibility on the other to solve the issue, it is neither the current RBI Governor nor the current Government which should be blamed for it. Anyone with some knowledge of the functioning of Indian banking would know how the NPA in public banks were mounting for years. To understand how NPAs became a monumental problem, we need to understand the following — If banks lend money to a borrower, and the borrower cannot repay the money back in time due to some genuine reasons (bad business, financial issues etc.), banks are allowed to take a stock of the situation and if they are convinced that the borrower has the intentions to pay the bank back but because of certain circumstances he/she couldn’t, then they can repackage such a loan with a new repayment plan, which the borrower will have to follow and repay the money back under the extended timeline. While this clause was meant to protect the interest of borrowers who didn’t intentionally default on their payments, it was exploited by banks to repackage any and every loan which went bad, so that it doesn’t appear in their books as a loss in a particular quarter, and is pushed into future to be handled later, probably by someone else.
While this tactic can work in the extreme short-term, but the bad loans eventually pile up until we reach a point where the whole banking system would collapse. And this is what was happening to the Indian public sector banks, and all the previous Reverse Bank Governors (including the much-hyped Raghuram Rajan) and the Finance Ministers were well aware of it, but since no one wanted to take responsibility for the mess of their predecessors, everyone just continued passing the ball, hoping that the ticking time bomb will not burst, while they are in power.
I am at least glad that the current government had the courage to accept that there was a problem in the system, and is now trying to solve it. Though the RBI and GOI should have worked hand in hand to solve it without passing the responsibility to other, but we will have to agree that the problem was huge, and anyone who took it in their hands was supposed to burn themselves, and that is what happened. But, thankfully, we averted a potential financial crisis in the process.
Now, there definitely is a need to fix the problem, but can we put all financial activities on the back burner in order to fix this one problem — definitely, No!
Fixing old problems and charting into new territories has to go hand-in-hand for the growth of the country, but having known where we had gone wrong in the past, treading with caution was the key, and that was the consensus which neither RBI nor the Government could reach.
While whatever is happening in the current economic scenario is far from ideal, and only time can tell if the RBI or GOI was correct in their approach. But, what the Government needs to understand is that Governors of Reserve Bank are experts in their field and if they say something, it should be considered seriously. And, the Governors of Reserve Bank need to understand that no matter how illustrious their careers might have been and irrespective of degrees they hold, they do not know it all, else the world would have never seen any financial crisis or economic turmoils — which, happen regularly!
But in the end, the people of India are going to be the real winners, because if what RBI is doing was wrong, then our Government just saved us and if what the Government is doing now is wrong, then very soon they will be voted out of power.
And, that my friend is the beauty of Democracy!
References:
[1] https://www.dnaindia.com/business/report-crucial-rbi-board-meet-today-to-iron-out-differences-with-government-2687065
[2] https://www.indiamacroadvisors.com/page/category/economic-indicators/financial-markets/foreign-exchange-reserves/
[3] https://economictimes.indiatimes.com/industry/energy/oil-gas/india-set-to-pay-for-iranian-oil-using-rupees-from-november-sources/articleshow/65887179.cms
[4] https://www.indiatimes.com/news/india/no-more-dollar-trade-friends-india-uae-sign-pact-to-trade-in-rupee-and-dirham-358038.html
[5] https://en.wikipedia.org/wiki/Tobin_tax
Originally published at apoorvpurwar.wordpress.com on December 11, 2018.
