Urjit Patel, India’s central bank governor, has abruptly resigned following a tussle with Prime Minister Narendra Modi’s government over the Reserve Bank's independence and a wide range of central bank policies. The Indian rupee plummeted 1.6 percent to a one-month low of 72.46 per dollar in early trade, but pared some losses to trade at 72.24 by 0435 GMT versus its previous close of 71.35.
In a sign of just how badly the markets have reacted to Patel's resignation that even the Pound amidst the Brexit uncertainties and a delayed vote, strengthened against the rupee trading at 91.12 versus the previous day of 90.50.
“However, a lot of the losses would have been capped between yesterday and today. And owing to uncertainty both with regards to Brexit vote and chaos in the political economy in India, the exchange rate of GBP/INR is likely to fluctuate in the range of 90-92 Rupees,” said Rishi Patel, Currency Account.
Dr. Raghuram Rajan former RBI governor's first reaction to the Patel's resignation was how "all Indians should be concerned” and in an interview to ET he noted “how this should be seen as a sign of protest”
It must be observed that Mr. Patel is the second RBI Governor to depart under the present BJP-led government. Mr Patel cited “personal reasons” for his decision to step down from the position he has held since the government declined to extend the tenure of his predecessor, Raghuram Rajan, in September 2016. Mr. Patel's decision was posted as a statement on the Reserve Bank of India website, and is effective immediately. His exit comes just days ahead of what was likely to be a fiery meeting of RBI governing board, during which highly contentious issues — including New Delhi’s demand for higher payouts to the government from the central bank’s surplus reserves to fund the fiscal deficit— were tabled for discussion.
The RBI and Mr Modi’s government were at a face-off for months over the central bank’s monetary policy, its measures to tackle bad loans, Non-Performing Assets (NPAs) at India’s state banks and the liquidity squeeze that followed trouble in the shadow banking sector.
PCA framework and regulations
Currently, the banks are regulated under Prompt Corrective Action (PCA) which was introduced by the RBI in 2002, and reviewed in 2017 following stressed assets and bad loan crisis in India. In other words, PCA is a quick corrective measure taken in case a bank is found to be having low Capital Adequacy Ratio (CAR) or high NPAs. RBI initiates PCA when CAR goes below 9% or NPA rises above 10%.
“The PCA framework is not at all good for us,” said a banker who did not want to be named.
“While we cannot lend money to our borrowers, the NPAs stand as they are. When we cannot generate money from the revenues from sanctioning these loans then how can we convert our losses into profits?” he asked.
One of the biggest points of difference between the RBI and the Modi government is the issue of imposition of PCA. Modi government is trying to “meddle” into the working of the RBI wherein it wants for the PCA norms to be relaxed so that lending to the Micro, Small and Medium Enterprises (MSEMs) can be allowed. This addresses the issue of credit crunch in the economy and simultaneously providing financial aid to uplift these small sectors.
Politics of double-edged sword
Many in the country, however, see the government's strategy as a political move that comes just before elections with the intention of gaining votes from these sectors at a time when unemployment is rave in the country and growth has suffered flowing the double blow from a hastily implemented GST and demonetisation.
“The BJP came to power stating that the RBI is not doing enough to clean-up the banks and bad loan crisis. Now when the RBI has taken this initiative there is no reason for the government or the finance ministry to interfere into the working of the institution,” said another banker who wished to stay anonymous.
“The PCA is a double-edged sword!” he explained saying how for “financial aid, the bank has to have enough capital to be able to sanction these loans and earn revenue from them. You can't dip into the red and then expect the RBI to pull them out using its capital reserves.”
Under PCA, banks are mandated to cut lending to corporates and focus on reducing concentration of loans to certain sectors. They are also restricted from opening new branches and paying dividends. Currently, 11 public sector banks and one private sector bank are operating under PCA. But the PCA framework is applicable only to commercial banks and not extended to co-operative banks, non-banking financial companies (NBFCs) and FMIs.
At a 10-hour-long board meeting last month, under heavy pressure from government nominees, Mr Patel made a number of concessions including promising to review restrictions on fresh lending by banks that already have high levels of bad debt. Banks are also supposed to comply with the internationally agreed Basel-III norms by March 2019, for which they need Rs 1.2 lakh crore additional capital in the next five months.
Urjit Patel was widely expected to quit for weeks, though his term officially ends next month. In the meantime, BJP has brought in IAS officer Shaktikanta Das as the new RBI governor. But what concerns the Indian markets as well the Forex is that this is third governor appointed at the RBI in the last 3 years. And perhaps the reasons for the stepping down of previous governors be it Urjit Patel or Raghuram Rajan is the food for thought among economists and politicians.
