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Economy

India's central bank leans closer to Modi with extra dividend

New governor stakes out a middle ground, not irrationality, analysts say

Shaktikanta Das, the new Reserve Bank of India governor, is trying to find a middle ground, analysts say.   © Reuters

MUMBAI -- The Reserve Bank of India's decisions to pay an interim dividend to the government and cut its policy rate herald the beginning of an era, one in which the institution acts more pragmatically and in harmony with government policy, economists and analysts say.

Experts believe the decisions by Shaktikanta Das, the bank's new governor, were made to support growth and boost fiscal spending ahead of elections in May, in which the government of Prime Minister Narendra Modi will seek a second term.

The interim dividend, 280 billion rupees ($4 billion), was paid on Feb 18. It amounts to roughly 1% of government's planned expenditure in fiscal year that ends in March. Whether to pay it was a point of contention between previous Reserve Bank Gov. Urjit Patel and the government. The argument was also a big reason why Patel resigned from the post in December. The payout comes on top of an annual dividend of 400 billion rupees for the year ended March 2018 and gives Modi's government 680 billion rupees for pre-election spending.

The money is a boon to a government that is trying to keep the fiscal deficit at 3.4% of GDP without curtailing its spending.

Part of the dividend seems to have been used to recapitalize some state-owned banks. On Wednesday, the government injected around 480 billion rupees into 12 banks to help them meet their capital requirements.

Some of the rest is expected to go to farmers as well as to government health care and pension commitments.

The dividend comes on the heels of another surprise move made to stoke growth, a rate cut of 25 basis points. The RBI's monetary policy committee also changed its stance from "calibrated tightening" to "neutral," clearly signaling a shift to a more dovish policy.

In a note issued on Feb. 14, Nomura analysts said that "under the new RBI governor, these relative weights appear to be shifting. In his maiden monetary policy statement, Das said the surprise rate cut was a result of low headline inflation and that once the price stability objective had been achieved, the RBI would address the objective of growth."

The cut came despite high core inflation.

In other recent decisions, the RBI eased conditions for lending to shadow banks after a crisis triggered by IL&FS and removed lending curbs on three public sector banks that were on a watchlist.

Default by IL&FS in September triggered widespread alarm over the prospect of a wider credit crunch should the company with $12 billion in debt become insolvent, as many banks, insurance companies and mutual funds are exposed to its debt and other nonbanks' debts. 

For now, economists and analysts are not concerned that the RBI is giving up its independence -- an outcome that had been feared amid previous government-central bank spats.

According to Sunil Kumar Sinha, the principal economist and director of public finance at India Ratings, Patel tread with caution and worked strictly by the rulebook during his stint as RBI governor. Patel's replacement, though, has adapted an approach that puts the onus of running an economy as much on the central bank as on the government.

Sinha points out that while the governor has agreed to the dividend payment and rate cut, he has maintained his ground on the February 12 Circular, which mandates that banks classify a loan as stressed even if is in default by a single day. The circular also requires that banks refer stressed loans of over 20 billion rupees to the company law court.

"Broadly," Sinha said, "the new governor is trying to find a middle ground."

The Nomura analysts warn that while accommodative macro policies do not necessarily imply imprudence, policymakers have to guard against pragmatism reaching into irrationality.

"For example," the note says, "ensuring adequate liquidity for non-bank finance companies is essential to prevent a liquidity crisis from morphing into a solvency crisis; but too much liquidity is also a bedrock of future inflation.

"Banks need an exit route out of the PCA (Prompt Corrective Action) framework, but if these banks lend to risky sectors again, then they could dig themselves into a bigger hole. Forbearance only kicks the can down the road."

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