Here's why the standoff between the govt and RBI could escalate further

On April 6, the RBI directed all payments service providers to store their data only in India
India’s government is asking the central bank to hand over a part of its surplus reserves and loosen liquidity norms for lenders -- demands that are likely to escalate a standoff with the monetary authority that’s fiercely protective of its independence.

The matter is pending before the board of the Reserve Bank of India and may be taken up at its next meeting likely on Nov. 19, a government official told reporters in New Delhi, asking not to be identified citing rules. The norms for sharing excess capital reserves should be set in line with established global practices, the official added.

Access to the capital reserves will enable Prime Minister Narendra Modi to meet budget goals, and any easing of capital adequacy norms for banks will help kick-start lending, boost consumption and economic growth ahead of a general election next year. The demands, however, are expected to further fuel tensions with the RBI, which has been pushing back at any moves that may derail its efforts to clean up the nation’s banking system.

While the central bank may be open to easing liquidity rules, including by injecting cash through open market purchases of bonds, it’s clear that it doesn’t want to part with its reserves or relax capital adequacy norms for lenders, people familiar with the matter said, asking not to be identified as they aren’t authorized to speak to the media.

Last year, the RBI parted with Rs 100 billion ($1.38 billion) more as an interim dividend -- an idea opposed by Governor Urjit Patel as he seeks to strengthen the central bank’s balance sheet to prepare for contingencies, including volatility in global financial markets and meet payments for currency operations.

People’s Money

The reserves are people’s money and the central bank is holding on to it aimlessly, the official said, adding that most central banks around the world keep 13 per cent to 14 per cent of their assets as the reserve, compared with the Reserve Bank of India’s 27 per cent.

While D.S. Malik, a spokesman for the finance ministry, didn’t respond to two calls for comments, a spokesman for the RBI couldn’t be immediately reached for a comment.

“There is no proposal to ask the central bank to transfer Rs 3.6 trillion ($49.5 billion) or Rs 1 trillion to the government, as speculated,” Subhash Chandra Garg, the secretary of Economic Affairs in the finance ministry, said in a Twitter post-Friday.

“The only proposal under discussion is to fix appropriate economic capital framework of RBI” -- with appropriate being the operative word.

Deputy Governor Viral Acharya, in a speech on October 26, suggested that the concept of excess reserves is certainly open to debate, but using central bank reserves to pay government obligations is not a positive development.

The government, which has a fiscal deficit goal of 3.3 per cent of gross domestic product for the financial year through March, is very much on track to achieve that despite cutting market borrowings, Garg said on Twitter.

Very Stringent

The central bank’s prescription for capital adequacy ratio, a measure of a bank’s financial strength, of 9 per cent is also a thorny issue for the government. Those norms are very stringent compared with global standards, the official said, citing the Bank of International Settlements’ 8 per cent.

The liquidity squeeze in non-banking finance companies could have a spiral effect and impact growth if not addressed immediately, the official said. That goes against the grain of the central bank’s attempts to clean up the banking system, which has the worst bad-loan ratio among major economies after Italy.

The RBI placed 11 state-run lenders under the so-called prompt corrective action framework that curbs lending, expanding branch network and dividend distribution.

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