The recent spat between the government and the Reserve Bank provided a lot of grist for the media mills. There are a few causative factors at the political level.
First, for long the RBI Governor’s post had been the prerogative of the IAS. The officials familiar with the demands of fiscal requirements could be better appreciative of the government’s needs.
Professional economists would often be more concerned with the nuances of monetary policy. They would be sticklers to the main mandate to regulate the issue of bank notes and building reserves with a view to securing monetary stability and generally to operate the currency and credit system of the country to its advantage. Also, they would be interested in having a monetary policy framework to meet the challenge of an increasingly complex economy and to maintain price stability while keeping in mind the objective of growth. This is a very wide area and there are various legislative enablers like the Banking Regulation Act. Even the bureaucrat-economist Dhuvvuri Subbarao was totally fixated with controlling inflation and for successive 13 quarters raised interest rates.
Dr. Raghuram Rajan who also had a stint with the finance ministry as Chief Economic Adviser, was appreciative of the government’s need. In his tenure, RBI transferred the entire surplus to the government. However, concerned with the chaotic state of affairs at banks with the compulsion for frequent capitalisation and mounting NPAs, he tightened the screws. Accustomed to years of window-dressing and restructuring loans, especially of large borrowers, the banks’ capital were seriously eroded.
Poor state of centre’s finances
There are a couple of reasons for the recent confrontation. First, the poor state of Central finances. Direct tax collections, though buoyant, were short of 1 percentage point of the target of 14.5 per cent growth. But in terms of indirect taxes, it was far worse, a growth of just 4.5 per cent. Even in the first half of the current fiscal, the fiscal deficit was around 95 per cent of the target for the full year.
There were shortfalls in other heads: against Rs.80,000 crore targeted for disinvestment, in the first six months realizations were just around Rs.9,500 crore. So the concerns of finance minister Arun Jaitley are understandable. Hence, the suggestions floated to reduce the contingency reserve for monetary emergencies from the present 27 per cent to around 13 per cent. Presently, RBI reserves amount to around Rs.9.4 lakh crore comprising around Rs.5.8 lakh crore of reserves and Rs.3.6 lakh crore as contingency reserves.
There is a facile comparison with the UK limiting contingency reserves to 13 per cent which is patently absurd. The UK is a mature economy with strong checks and balances. Average inflation has been just around 1 per cent for the UK. In India, inflation had shot up to 14 per cent and more on several occasions. While the Pound sterling has been reasonably stable, the rupee has been depreciating against major currencies, at times steeply.
The Gurumurthy factor
There is also the Gurumurthy factor. This expert on financial issues, known for his deep knowledge of economic issues particularly on corporates and political activism, has strong views on fiscal and monetary matters. He has been almost obsessed with the need to give high priority to the Micro, Small and Medium Enterprises (MSME) sector as also to the Non-Banking Financial Institutions (NBFCs). He articulates his strong support of these two sectors through his prolific writings and addresses in various fora. The Mudra Bank emerged due to his advocacy to recognize the handsome contribution of the MSME sector in the production and export of goods and employment. However, unfortunately, he has been almost totally blind to the obstinate resistance of these sectors towards contributing to the tax efforts.
Remember the stiff resistance to the simple and elegant demand for compliance with the presumptive tax that demanded an annual tax of just Rs.1400 with no questions asked about book-keeping? The sector also distributed the businesses under various family ownership to gain the incentives and advantages of investment limits. I belong to this sector and I am familiar with the difficulty of making large sections of small and medium businesses to adhere to tax compliance.
Thank God, the marathon meeting of the RBI Board on 19 November concluded without much damage. For this, credit should go to RBI Governor Urjit Patel who met Prime Minister Modi the previous week; which should have helped defuse the crisis. The differences that surfaced need to be reconciled by measures that would ensure monetary stability over the medium and long-term. – SV
