After weeks of tension, the Reserve Bank of India gives in to some of the central government's demands while retaining its independence

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  • Following a nine-hour meeting, the board of the RBI and officials from the central government were able to reach a compromise on a number of issues.
  • The central bank agreed to implement measures to improve the flow of credit to the micro-small-and-medium enterprise (MSME) sector and to work towards easing restrictions on state-owned banks.
  • The RBI also decided to institute a panel that will decide upon the transfer of its surplus funds to government coffers and review the reserve capital requirements imposed on Indian banks.
As predicted, the Reserve Bank of India (RBI) and the central government were finally able to reach a truce following a marathon meeting of the 18-member board of the central bank on Tuesday.

Among the many concessions the RBI agreed upon, the main ones were to implement measures to improve the flow of credit to the micro-small-and-medium enterprise (MSME) sector and to work towards easing restrictions on state-owned banks. While the two parties will continue to differ over a number of issues, the central bank is expected to retain its autonomy when it comes to decision-making.

Terms of the truce

Given the ongoing liquidity crisis in the non-banking financial sector, the central government had been vocal about the slowdown in credit to small businesses around the country. The RBI had opposed the ask saying that easing credit could result in a further pile-up of bad loans. Over the course of the November 19 meeting, the board of the RBI decided to formulate a scheme to restructure the bad loans of SMEs to the tune of ₹250 million or less in lieu of access to additional financing.

Secondly, the RBI agreed to review the restrictions imposed on banks under its Prompt Corrective Action (PCA) framework. Most of the banks on the PCA watchlist are state-run banks given their disproportionately large share of non-performing loans in the Indian banking sector and recent history of losses.

Following the review, the RBI’s Board of Financial Supervision is expected to release some banks from the programme - something that the government has insisted upon. Speaking to media outlets on Monday, the principal economic advisor to the government, Sanjeev Sanyal, said that it was imperative for there to be an exit plan in place for banks under the PCA framework.

Thirdly, the board of the central bank decided to institute a panel primarily tasked with deciding upon the transfer of surplus funds to government coffers and review the reserve capital requirements imposed on Indian banks. The Indian government has recently raised demands that it should receive a larger share of RBI’s surplus funds as it struggles to meet its fiscal deficit target. The ask was strongly opposed by RBI, which said it needed stronger cash reserves in the event of a financial downturn.

While the RBI decided to retain the capital adequacy ratio for banks at 9% of risk-weighted assets, which is one percentage point more than what is prescribed under Basel III norms, it has given them an additional year to implement Basel III requirements by March 2020.

The compromise came as a relief to market speculators as fears about the resignation of RBI governor Urjit Patel were put to rest. Both the R upee and Sensex index were up Monday, while prices on 10-year government bonds also increased.

The truce, by no means, indicates an end to disagreements between the government and the central bank, which isn’t a bad thing. Given the difference in their goals and the timeline of their mandates, the two parties may butt heads again over a number of issues. However, the outcome of the board meeting of the RBI shows that when needed, a compromise can be reached and long-term stability can be reconciled with short-term boosts to the economy.

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