MUMBAI/ NEW DELHI -- A slowly brewing storm over the past few months between the Indian government and the Reserve Bank of India has finally culminated in a public war of words amid rumors the central bank governor Urjit Patel is on his way out. Now with businesses turning clearly to the government's side, RBI is finding itself in a lonely fight.
At the heart of contention are policy issues such as liquidity for nonbank financial companies, capital requirements for weak banks and lending to small and midsize businesses -- areas in which RBI's moves have been at odds with the government's expectations.
Amid the heated exchange between RBI and the government, the Confederation of Indian Industry released on late Wednesday a long list of issues that require "immediate intervention" of the RBI.
"While the fundamentals of the Indian economy remain robust, the financial sector in the country is undergoing a phase of challenge, which can become a big hurdle to the growth story of India," it said in a statement.
The industry body said RBI should reconsider the restrictions it placed on the 11 banks that have come under its scrutiny and allow them to lend to the National Housing Bank which can then use those funds to finance housing projects.
The confederation also said: "RBI must work out further credit lines to provide sufficient liquidity as otherwise a severe credit crunch will dent consumer demand and growth of Indian economy."
The government led by Prime Minister Narendra Modi called a truce on Wednesday to calm financial markets, stressing the autonomy of the central bank was "essential." After a fall on Wednesday, the rupee steadied on Thursday at around 73.8 per dollar.
But the government added it would continue to hold extensive consultations with RBI on key issues. According to the Economic Times newspaper, the government has invoked Section 7 of the RBI Act that gives it the power to tell the bank what to do, after consultation with the governor.
With elections in some key states around the corner and general elections due by May next year, the government has taken measures such as bringing down fuel prices.
They are largely driven by "political-economic consideration and are not entirely based on the economic logic," said Professor N. R. Bhanumurthy of New Delhi-based National Institute of Public Finance and Policy. "The RBI cannot do such tinkering because they need to have some kind of stability in most macro parameters. So, if fiscal [policy] relaxes somewhere, monetary [policy] has to tighten somewhere."
Investment bank Societe Generale said in a report released on Wednesday that RBI's adherence to prudence is justified given the high level of nonperforming assets owned by banks, even if growth is temporarily sacrificed in the clean-up of the banking system.
"Why does [the government] want faster credit growth when the data for the latest week shows credit growth of 14.5% year-on-year," it said in a note. "The answer may lie in the fact that bank credit is not going to areas that can create jobs... With job growth remaining anaemic, this is not good news for the government in the run-up to the 2019 election."
One of the government's key promises during the 2014 election was adequate job creation.