After an openly fractious build-up to the board meeting of the RBI on Friday, both the government and the central bank now appear to have stepped back to work out solutions to contentious issues. That should calm the financial markets and investors worried about the fall-out of the stand-off. On two issues, the RBI will now be guided by the advice of its board — on funding of small and medium firms hurt largely by the government’s demonetisation move and the subsequent slowdown and on a review of the existing framework on Prompt Corrective Action (PCA) which places fetters on lending by 11 state-owned banks. The RBI will now finalise a loan recast scheme for SMEs up to a ticket size of Rs 25 crore with conditions which would ensure that financial stability is not imperilled. Similarly, the RBI’s Board for Financial Supervision will review the PCA framework to assess if some of the lenders can be freed from the restrictions and to help boost credit flow.
The regulator has also agreed to some forbearance in terms of the capital requirement for banks by easing the deadline for maintaining the capital conservation buffer by an year to the end of March 2020 although it has not bought the government’s argument that the RBI should lower the capital norm of 9 per cent to 8 per cent in line with internationally accepted Basel norms. The board has wisely left it to an expert committee to determine the economic capital framework of the central bank including the controversial issue of the transfer of surplus. Importantly, this will be for future transfers, thus putting a lid on the current controversy on the level and size of transfers the government is entitled to.
For now, both sides have settled for a truce, but whether this is enduring will be known only when there is closure on issues such as liquidity for NBFCs and governance in RBI. That also raises the larger question of whether significant policy decisions should be pushed through with national polls just six months away. On the RBI’s part, just as it forcefully articulated its pushback, it should engage more with the government and also communicate better. It is important for both the government and the RBI to resist the temptation of portraying the boardroom developments as a victory or a climbdown. Monday’s outcome, however, cannot cloud the fact that the issue of fiscal management and repairing of bank balance sheets is far from being fully addressed.