Dr. Y. V. Reddy, former governor of the Reserve Bank of India (Photographer: Namas Bhojani/Bloomberg News)

YV Reddy Weighs In On The Tussle Between RBI And Government

There is an unwritten, unsaid tradition among the small community of former Reserve Bank of India governors. They will speak most sparingly on issues the RBI may be dealing with in the present to ensure they dont muddy the waters for the person occupying the governor’s office at the time. Be it C Rangarajan, Bimal Jalan, YV Reddy, D Subbarao or Raghuram Rajan, each of them will refrain from weighing in on issues related to the RBI directly. Unless they feel they must speak up.

On Friday, Yaga Venugopal Reddy decided it was time to speak up.

While delivering the Kale Memorial Lecture 2018 at Pune’s Gokhale Institute of Politics and Economics, Reddy shared his thoughts on issues that led to months of friction between the RBI and the government and finally ended in the resignation of former governor Urjit Patel.

The issues relating to capital framework, the regulatory relaxations and the role and composition of (RBI) board will have a lasting impact on RBI, Reddy cautioned.

Coercive Monetisation Of Fiscal Needs?

Addressing the continued clamour from the government for RBI reserves and a larger dividend from the RBI, Reddy noted that some critics have seen this as a replacement of the “automatic monetisation of the pre-reform period” with what may be termed as “coercive monetisation of fiscal needs.”

The government has argued that the RBI is sitting on excess capital. After a bitter battle over the issue, a committee headed by former governor Bimal Jalan has been set up to examine the matter. But even before the committee submits its report, the government is seeking an interim dividend, which includes funds transferred to the RBI’s reserves in previous years of FY17 and FY18.

In seeking such interim dividends, “immediate fiscal needs seem to take precedence over a renewed assessment of the capital needs of RBI”, Reddy said.

He added that such interim dividends contradict the spirit of putting in a limit on ‘ways and means advances’ which are intended to meet any short-term funding mismatch that the government faces.

Reddy acknowledged that, in ultimate analysis, the government has claim over the reserves. But the way it exercises this claim, “gives signals to the market and influences public opinion.”

The former governor went on to explain the two approaches that can be taken towards the central bank’s balance sheet:

  • One view is that the government will provide support to it when needed and hence issue of adequacy does not arise. All income over expenditure every year could get transferred to the government.
  • Alternatively, the government may like to assure the markets that its central bank has the capital to meet contingencies that may arise without depending on governments.
There is merit in keeping at least central bank’s balance sheet strong if the government’s fiscal balance sheet is weak. But substantively, it is the judgment of the government that prevails on the adequacy issues though procedurally that of board.
YV Reddy, Former RBI Governor

Banking Regulation: Diluting RBI Autonomy And Accountability?

The RBI and the government have also differed on the regulator’s decision to impose prompt corrective action on weak public sector banks. Until last month, 11 banks were under these restrictions. Three have now been released even though they have just about started to show an improvement in their financial indicators.

Reddy questioned whether the government, in pushing for relaxations of the PCA framework, is damaging the autonomy and accountability of the RBI.

This is certainly an operational matter and a matter on which the government-owned institutions could make representations to the RBI for consideration. There can be genuine concerns of the government, but governments generally persuade the regulator but not direct it in such matters. Obviously, the government is tilting in favour of their own regulated entities who failed to convince the regulator in the matter, though the RBI is the agent of government fully equipped to take a view on the matter. In a manner, this dilutes both the autonomy and accountability of RBI.
YV Reddy, Former RBI Governor

Apart from opposing the PCA norms, the government has also sought relaxations in the version of Basel norms implemented in India. The argument is that these norms are more stringent than global norms.

Reddy explained that there is a reason for this.

Basel-III norms assume a particular level of realisable value of the assets in case they becomes non-performing. “In India, the transactions cost and the liquidity in relevant markets, in particular in real estates, make the realisable value generally far less than the declared value,” Reddy explained.

There is, thus, a case for the Indian norms to be more stringent than global ones, said Reddy, adding that it’s an operational matter for the RBI to decide on.

Financial Sector Accidents

Reddy noted that over the last couple of years, the RBI has found itself on the defensive. Between the delayed recognition of bad loans and large frauds, questions have been asked whether the RBI failed in its regulatory duties.

Reddy highlighted three cases -- the fraud at Punjab National Bank, the lending from IDBI and SBI to Vijay Mallya and ICICI Bank’s lending to the Videocon Group.

According to Reddy, the responsibility for each of these lies first with the boards of the respective institutions. “All these were essentially in the nature of frauds committed for which the responsibility rests with the management of the respective Boards. The owners should be most concerned though,” he said.

Reddy took a similar view on the collapse of IL&FS Ltd.

While the RBI was blamed for not providing enough liquidity to support the markets after IL&FS filed for bankruptcy, Reddy questioned whether the issue was one of solvency or liquidity. He also asked whether the incident reflected on the ability of two large public sector enterprises -- SBI and LIC -- to assess risk.

If IL&FS faced a liquidity problem it would have been the responsibility of RBI. Obviously it is an insolvency issue since the Government intervened. Perhaps, Government intervened since both LIC and SBI owned by it are large stakeholders in IL&FS, and also because many infrastructure projects are involved.  In any case, RBI should be concerned at the risk assessment capabilities of public sector giants like LIC and SBI that allowed this to happen while having large stake in IL&FS.
YV Reddy, Former RBI Governor

Governance Of RBI Board

The former governor also raised questions about the proposal to review the structure of the RBI board. Ahead of Urjit Patel’s departure from the RBI, the government has sought to push more powers onto the RBI board, which is so far an advisory body.

“ ...if the role of the board is being reviewed, it should encompass the composition of the board and relations between the board and government as well as governor,” said Reddy.

He pointed out that all board members are picked by the government and the board currently focuses on house-keeping and renders advice and guidance on policy. If the role of the board has to be rethought, it should be done keeping in mind global practices and the changing domestic scenario.

The issues relating to capital framework, the regulatory relaxations and the role and composition of board, will have a lasting impact on the RBI.
YV Reddy, Former RBI Governor

A Time Of Rebalancing

Reddy, as always, peppered his speech with the history of the Reserve Bank and how it has evolved over time.

He spoke of the phase between 1950 and 1970, which was one of planned fiscal dominance. That phase made way for a period of fiscal and financial sector dominance between 1970 and 1990. This was a time when the RBI became directly associated with the cost and disbursal of credit based on the plan priorities of the government.

The period between 1990 and 2010 was a period in which the RBI and the government coordinated on crisis management and reform. “In April 1998, the RBI decided to switch over to multiple indicators approach as a new framework for the conduct of monetary management which looked at a variety of financial market and economic indicators to evolve appropriate stance of monetary policy,” Reddy recalled.

He sees the period starting 2010 as one of “rebalancing and a new framework.”

Over this period, the government has reduced its dependence on the RBI to decide upon the intellectual framework for financial sector reforms. The task of monetary policy has been handed over to a monetary policy committee. The RBI’s monetary management was also temporarily impacted by the announcement of demonetisation.

The Reserve Bank of India seems to have reluctantly acquiesced (to the idea of demonetisation) after Governor Raghuram Rajan had orally expressed reservations before he vacated the position at the end of his term. The (demonetisation) decision was implemented during Dr. Urjit Patel’s tenure.  The RBI had to take the blame for the significant pain that was caused to the general public during the period of implementation.
YV Reddy, Former RBI Govenor

Finally, in 2018, the government decided to call for consultations under Section 7 of the RBI Act for the first time in history, before former Governor Patel decided to leave for “personal reasons”, Reddy pointed out.

Not The First Time

Reddy reminded his audience that this isn’t the first time that the RBI and the government have seen friction. He started his speech by recalling a lecture by CD Deshmukh at the same occasion in 1984. That lecture too was delivered in the backdrop of differences between the government and the RBI on nationalisation of Reserve Bank.

Reddy closed his speech by quoting from the same lecture delivered 35 years ago.

“After all, it is not the theoretical constitution of the institution that matters, but the spirit in which the partnership between the Ministry of Finance and the bank is worked. The success of the partnership will, in the ultimate analysis, depend on the manner in which the government desires to be served and provides opportunities accordingly. No country can have better public institutions than it deserves.”

Also read: Full Speech Transcript: YV Reddy Weighs In On RBI’s Balancesheet, IL&FS And More