Economic affairs secretary Subhash Chandra Garg explains why the Reserve Bank of India’s (RBI) governance structure and the economic capital framework need review, while asserting that the government would meet this year’s fiscal deficit target of 3.3% of the gross domestic product, without a major capex reduction. With oil prices on the decline (Brent crude plunged from a $85-plus/barrel in early October to around $63 now) and reduced concerns on the current account, coupled with demand-side factors, could bring down bond yields further to 7.5% in some time. In an exclusive interview with FE’s Banikinkar Pattanayak, he said, “Our sense is that liquidity-related solvency concern is no longer there (for NBFCs). But there could still be a shortage of the liquidity, in terms of the ability of these firms to carry on with their businesses even with a reduced speed.”

Q: The Centre’s fiscal deficit in the first half of this fiscal was 95.3% of the annual target, versus 91.3% of the respective target in the corresponding period last year. Even by the usual standards – the deficit even exceeds 100% of the annual target towards the final months of a year but later gets reined in with budgetary management including expenditure control –, this seems high. Given that last year, the government had to allow a slippage of 30 basis points from the budgeted level of deficit (it finally settled at 3.5% of GDP versus 3.2% envisaged) even after a marginal expenditure cut, tell us why you are, as you stated earlier, very confident of meeting this year’s 3.3% target?

The typical trend is that in the first half of a fiscal, the deficit is always higher. That is because our income tax receipts are much lower in the first half. Typically, income tax receipts will come to be about 40% or even less in H1. Several tax receipts and others are much less in the first half. Expenditure is more front-loaded in the first half especially after this change (in Budget date) from February 28 to February 1, and the whole budget being approved by March 31. So the H1 figures are not an indication that it is necessarily going to affect our fiscal deficit target. We need to see on the whole how things are shaping up for the remaining months and how expenditure is going up
cyclically or otherwise. So our assessment at the moment is that, on the revenue side, there might be a small shortfall in the GST. It is difficult to quantify the shortfall and we will have to wait for the numbers for this month to come in.

Q: Big shortfall is seen in the GST revenue (analysts estimate it to be in the range of Rs 30,000-100,000 crore) that would go to the central budget. Net tax receipts (post-refunds and post-devolution to states) grew just 7.5% in H1 compared with 19% growth needed to achieve the budgetted target.

The net corporate tax growth budgeted was 14% and actual performance is 17%. It is much better than last year. Given that corporate profits have been 22% higher than last year, our expectation is that on the direct tax side we will do much better. The GST revenue shortfall will be much smaller than predicted by many.

On the non-tax side too, we are also doing much better than last year. We hope to exceed the target. It might include a further dividend from RBI (by the time of interim budget, while the payment is actually due by June). Our companies (PSUs) are also doing well. Therefore some compensation (in the form of dividends/buyback) will take place from that side. We will achieve the disinvestment target as well and I have no doubt about that. There will definitely be at least one ONGC-HPCL-type big deal this year.

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Q: You have already spent Rs 1.63 lakh crore as budget capex, 54% of projected for the full year. Given the likely shortfall in revenue, won’t you require to slash capex/overall spending considerably in H2? Have you assessed its impact on growth?

There is an accounting issue here. The capex spent already could be some Rs 20,000-crore less (when net numbers are calculated). So we are perfectly on target (on capex). We will not compromise on this.

Q: What are the expenditure heads that might seen sharp upward revisions from budget estimates? The extra amount of Rs 15,000 crore provided for MSP (price support) schemes, for instance, seems grossly inadequate.

When (kharif) crops come in by November-December, the purchases are funded from bank credit etc. Public expenditure is actually incurred when you sell (the crops procured) at a loss. That sale is unlikely to take place before February-March. So the amount (Rs 15,000 crore provided) is more than enough. Next year, there will be a higher requirement and we will provide for it. On the whole, if you have full procurement (depending on marketable surplus and crop-wise procurement), there might be an impact of additional Rs 40,000-50,000 crore in a year (for the price support schemes).

Q: You had announced a plan to trim the Centre’s gross market borrowings for H2 by Rs 70,000 crore, which means full-year borrowings of Rs 5.35 lakh crore through reduced buybacks and aggressive tapping of NSSF. While this is expected to ease the pressure on bond yields, the larger bevy of sovereign-serviced government bonds – state governments have upped their exposure to market (borrowings are estimated to be 90% of their combined fiscal deficit this year versus 66% last year); central and central PSUs/undertakings have substantially increased their market borrowings too – might still keep the bond yields relatively high.

A: States have over the years become market-funded like the Centre with lesser reliance on NSSF. The combined fiscal deficit of states will be 2.6-2.8% this year. States have traditionally carried a lot of cash balances, some Rs 2-2.5 lakh crore at any point of time. Their total borrowing in a year is roughly Rs 5 lakh crore. In the beginning of the year, they plan 85% of their deficit funding from market borrowing, but during the course of the year, they reduce it because they are holding some cash. In the first quarter, they planned Rs 1.3 lakh crore, but they actually borrowed only Rs 85,000 crore. In the second quarter too, they borrowed less than planned.

As for the pressure on bond yields, it is also a function of demand. Banks, foreign portfolio investors, mutual funds etc. are major subscribers of the government bonds. This year, thanks to concerns of higher current account deficit, the FPIs became net sellers for some time, putting pressure from the demand side. For some time, banks reduced their subscriptions because they were holding more than what is statutorily required. This put some pressure on the yields, it went up to 8.22%. But, the yields are back now to roughly 7.71% now that the situation on the CAD has changed and FPIs are coming back. Banks are also coming back to the bond market. There is a lot demand now. When people see rupee appreciating, their demand for securities also will go up. So, taking all these factors together, there could be further reduction in yields. I won’t be surprised, if it declines to 7.5% in some time.

Q: The Centre’s net borrowings have remained static at around Rs 4 lakh crore over the last two-three years. However, to sustain public expenditure, which could potentially crowd in (long-elusive) private investments, the government seems to be relying on extra budgetary resources (off-budget borrowings) in a big way. Though EBRs may have a much lesser immediate impact on the exchequer than direct budget spending, they add to the overall stock of public debt.

A: Bulk of ther EBRs are being done by CPSEs. It’s roughly in the order of Rs 3-4 lakh crore. We have introduced some borrowing on the government account also as EBRs to fund Swacch Bharat Abhiyan, higher education etc. It is however not major programme, and will be hardly Rs 25,000-30,000 crore.

Q: Analysts have estimated the liquidity shortage at anywhere between Rs 80,000 crore and Rs 100,000 crore. However, just the turnaround in oil prices seems to be addressing the liquidity issue to an extent. The RBI is no longer under pressure to sell dollars and with the CAD fears allayed, the foreign portfolio investors might come back to the market.

The stated policy of the government is that you don’t have any target for either the exchange rate or reserves. Basically, you ensure there is no excess volatility. There should be an orderly transition, that is all.

On liquidity, in September or early October, there were concerns about certain segments in the market, even in terms of their solvency. Our sense is that liquidity-related solvency concern is no longer there. But there could still be a shortage of the liquidity, in terms of the ability of the NBFCs to carry on with their businesses even with a reduced speed. The concern is the ability to continue to finance. They (NBFCs) were financing a lot of consumption and investment and growing at about 40-50%. Roughly about 60% of net addition to the credit was coming from NBFCs in the last couple of years. Now they don’t have that much money to lend because they have less funds to first refinance themselves. This reduction in the pace of growth is affecting liquidity.

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Q: What steps can be taken to improve liquidity?

A: The traditional ways NBFCs were financing themselves have to change. They were financing by taking a lot of commercial papers. That route has got reduced substantially. They were also getting financed by banks. Mutual funds, LIC and people in general can invest in some of the NBFCs. The deposit programmes of the NBFCs have been fast-tracked as well. Also, the RBI has taken some measures like partial credit enhancement, change in concentration limits etc. so that banks can invest more in NBFCs. With all these, NBFCs have been able to raise funds but not as much as they would like to have for continued growth. Our sense is still that we need to do something more for some more time (to improve NBFC liquidity).

Q: Are you looking for a credit window from central bank?

A: The central bank, in our system, has never operated a direct credit window, it’s operated through banks. The banks are provided the facilities and they can to finance the NBFCs.

Q: Will the December 14 meeting of the RBI board take up the liquidity issue?

A: We will propose a discussion on liquidity and how to handle the systemic as well as segment-wise liquidity issues. Recently, the Financial Stability Development Council resolved to take all measures required to boost liquidity, keeping financial stability in mind. Improving or maintaining comfortable liquidity at the systemic as well as segment levels is what is required.

Q: What are the items for discussion in the next board meeting?

A: The other issue is (RBI) governance. The central bank’s governance structure has evolved over a long period of time and is a continuous process. So even in 2016, when the RBI Act was amended to create a monetary policy committee system, it was a reform.

The broad structure is like this: it is the central board of the RBI in which, by law, all powers relating to conducting the business are concentrated. Then the board makes regulations under Section 58, which is approved by the government, which decides what subjects can be retained by the board or given to the governor and other committees. Subject to the regulations made by the board and approved by the government, all powers available to the board are available to the government. All powers that are vested in the board are concurrently vested in the governor.

In 1949, the board made the general regulations under which they reserved a few powers for themselves and delegated most to the governor. That was the last general regulations. But effectively, the system has kept on evolving. So now what is being proposed is a discussion on the governance structure of the Reserve Bank. Over the years, the global financial system has become far more complex and globally integrated than in 1940s or 1950s. The governance practices have also evolved globally in tandem. The US Fed even conducts a public meeting now and has several committees on different aspects. The new regulators that have come up in India, including Sebi, also follow a system of making regulations, where public consultations are imporrtant. There has to be changes and improvements in the way central bank systems functions.

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Q: Will you issue (Section 7) directions if the RBI governor doesn’t agree to the government’s proposals on governance reform?

A: This is not a threat, it is rather a legal position. I don’t see any necessity (of issuing directions under Section 7). They are all mature, knowledgeable people and everyone knows what is the best way to manage the institution and serve the public interest.

Q: Will you propose an appellate tribunal for RBI as in the case of other regulators like Trai and Sebi?

A: There is no proposal for an appellate tribunal. But the absence of such a set-up for course correction places greater responsibility on the institution itself. Therefore, the mechanism should be seen as far more consultative and participative.

Q: The finance minister said the RBI looked the other way when indiscriminate lending by banks took place during the UPA era. Now, say, the RBI governor feels, given the asset-liability mismatch in NBFCs, credits to NBFCs need not grow so fast.

A: There are two issues. One is the institutional arrangement. They should themselves be more participatory, transparent. Second, actual use of authority. What finance minister was referring to was between 2008 and 2014, there was tremendous loan growth. So RBI is also a supervisor, those people who were working at that point (it’s not institution but people), they should have exercised that supervisory authority much better.

Q: Many NBFCs have ALM mismatches. So whatever structure you want to create, you don’t want all of them to have the same kind of access to liquidity.

A: The investors also look at these things. In the liquid funds, the companies who used to invest the most are asking where you are investing. This is a course correction. The investors are more careful now, and they may ensure the ALMs (of NBFCs) are taken care of.

Q: Who will head the panel on Economic Capital Framework (ECF), a government nominee or an RBI representative?

A: That process is on and at some point there will be a chairman whose name is endorsed by both the government and RBI.

Q: The RBI has been transferring almost its entire annual realised profits in recent years to the government, after the Malegam committee had estimated RBI’s extra reserves at Rs 149,000 crore. So when you seek a review of the central bank’s economic capital framework (ECF), do you intend to get larger share from the reserves built up over the years in the contingency and asset-development (internal capex) accounts or want the RBI to dip into its currency and gold revaluation accounts as well (a process that would need printing of banknotes, be tantamount to monetising the government deficit and stoke inflation)?

A: The economic capital deals with all the reserves that are in the buffer. First, we want a proper ECF, so the terms and reference will be decided for that.

The Section 47 of the RBI Act says the central bank will make all provisions including what “bankers normally provide.” It says the balance of profit shall be transferred to the government. So profits of the RBI belongs to the government. The issue is how much of the provisions to be made. That is where ECF comes to play.

Q: Does the profit include notional profits (from revalaution accounts)?

A: No, profits never include notional profit. The RBI system doesn’t take notional profit (valuation profit) to the profit-loss account. The ECF will determine how much reserves RBI should hold. The construct is if the reserves the RBI requires is more than what it has, then the surplus (needs to be determined).

Q: So does it mean if the RBI reserve requirement is 22% (of assets) and its holding is 28%, the extra 6% should be transferred to the government?

A: Not necessarily. Such a situation came when the Malegam panel assessed that the RBI was holding Rs 1.49 lakh crore extra. So he asked the RBI to transfer 100% of realised for the next three years and the central bank did it. And after three years, you reassess the requirement and transfer. So now is the time to reassess.