People stand in line to exchange Indian five hundred and one thousand rupee banknotes at the Reserve Bank of India (RBI) headquarters in New Delhi, India. (Photographer: Anindito Mukherjee/Bloomberg)

India Central Bank Signals Truce With Government on Reserves

(Bloomberg) -- India’s central bank signaled a compromise with the government by agreeing to study a demand for sharing a part of its capital -- an issue that had triggered a public spat between the monetary policy makers and their political bosses.

The Reserve Bank of India will form a panel to consider the funds transfer to the government, the central bank said in a statement after Monday’s board meeting that lasted a little over nine hours. It, however, did not immediately yield to demands for easing lending norms for weak banks while retaining capital buffers for banks at 9 percent.

The government and the RBI have been sparring over how much capital the central bank needs and how tough its lending rules should be. For a nation that relies on imported capital to fund investment, the reaching of a middle ground is key to retaining investor confidence in the world’s fastest-growing major economy.

Read Our Q&A Blog on Why India Raiding RBI’s Reserves Is a Bad Idea

The compromise suggests tough decisions have been kicked down the road, offering comfort to investors concerned about the threat to central bank autonomy, analysts said.

“The outcome of the board meeting suggests that a direct confrontation has been avoided and the more contentious issues have been deferred to committees,” said Sonal Varma, chief India economist at Nomura Inc. “Efforts have been made to preserve the RBI’s operational autonomy.”

India is not alone in witnessing friction between its monetary policy makers and the government. U.S. President Donald Trump has repeatedly criticized the Federal Reserve for raising interest rates while President Recep Tayyip Erdogan has leaned on Turkey’s central bank. Most economists argue leaving central banks to do their work free of political influence tends to lead to lower interest rates and inflation.

The rupee advanced and bonds rose Tuesday. The currency gained about 0.5 percent to 71.3237 against the dollar as of 11:54 a.m in Mumbai, while the benchmark 10-year bond yield fell 3 basis points to 7.76 percent.

India Central Bank Signals Truce With Government on Reserves

The board discussed Basel regulatory capital framework, a restructuring program for stressed small businesses, the health of weak banks placed under the so-called prompt corrective action and the economic capital framework of the RBI, the central bank said.

The 18-member board advised the RBI to consider restructuring of loans of up to 250 million rupees for small borrowers, it said.

Budget Goals

Getting the RBI to agree to its demands will help Prime Minister Narendra Modi’s government, which faces an election early next year, meet budget goals by using a part of the central bank’s reserves. The government also wanted norms for some banks to be relaxed so they can lend easily and keep the economy firing ahead of an election next year. An RBI panel will review those norms, according to the statement.

India Central Bank Signals Truce With Government on Reserves

Former Finance Minister P. Chidambaram said in a Twitter post he was glad the government had “stepped back and grudgingly acknowledged the independence of the RBI.” He added that most of the independent directors probably “realized that the government was on a perilous course and refused to go beyond giving advice to the RBI.”

The central bank -- led by Governor Urjit Patel -- had pushed back against some of the moves earlier, keen to burnish its inflation-targeting credentials and clean up one of the world’s worst bad-debt piles.

India Central Bank Signals Truce With Government on Reserves

That approach has broadly helped anchor inflation expectations in a country where prices have often risen sharply, eroding investor confidence and leading to sell-offs in assets. The six-member monetary policy committee has raised interest rates twice this year and its decision has seen headline retail inflation slow to a 13-month low of 3.3 percent in October.

“Both the RBI governor and the finance ministry walked the extra mile,” Sachin Chaturvedi, a member of the board said in an interview to Bloomberg on Monday. “They were flexible on several issues.”

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