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India Strategy: Dr. Patel’s resignation: - In a tough spot!

In a surprise move, Dr. Urjit Patel resigned as Governor of Reserve Bank of India (RBI), 9 months prior to the end of his tenure. The news came as a surprise amid public feud between the central government and the RBI on a variety of matters: a) Government’s intention to invoke section 7 of the RBI Act, which would have empowered the government to give directions to the central bank, thus superseding RBI’s autonomy b) government’s recent disagreement on RBI’s Prompt corrective action (PCA) on 11 PSBs (PCA prevents these banks from incremental lending until their financial health is restored) c) matters pertaining to liquidity of NBFCs and SME lending, d) doling out incremental dividend to the government from central banks’ surplus reserves (the government may be seeking Rs1trn from surplus of Rs9.5trn), e) dilution of Basel III norms (bringing capital to risk weighted assets ratio down to 8% instead of 9%), and, f) keep power assets out of the stressed assets framework. The resignation comes just before government’s meeting with the RBI board on 14 Dec 2018 on the above-mentioned issues. We believe the markets may read this resignation as a sign of protest. The resignation raises questions on RBI’s autonomy and could dampen the sentiment of foreign investors. As a result, we believe it would be extremely crucial that the government maintains the autonomy of the institution. Hence, a lot depends on appointment of next governor, in terms of timing as well as candidate profile. If the candidate is good and to market's liking, not much would be lost. While equity markets could remain volatile near term, given the announcement of state election results on 11 Dec 2018 and impending general elections, we reiterate our preference for quality names and certain growth stories.  

Issues between the central government and RBI with timelines

Dr. Viral Acharya’s (Deputy Governor of RBI) recent speech, which highlighted the need to maintain autonomy for the central bank, brought to the forefront the friction brewing between the central government and the RBI. The speech was a response to government’s call for consultation on section 7 of the RBI Act, which empowers the government to direct RBI, thereby superseding the central bank’s autonomy. Post the speech, government called for a meeting with RBI on 19^th Nov, which lasted 9 hours. We highlight few issues under discussion between RBI and government:

9. a) Government could seek part of RBI's surplus reserve of Rs 9.5trn as dividend: RBI has surplus reserve of ~Rs9.5trn, which majorly comprises contingency fund and currency and gold revaluation account. Government deems the surplus reserve is in excess of what the central bank actually needs to maintain. Though different media sources indicate Rs3.6trn worth of excess surplus reserve with RBI, in our estimate, government would seek Rs1trn from this surplus to meet its FY19 fiscal deficit target (at 3.3% of GDP). We would like to highlight that current fiscal deficit situation remains precarious with 104% of the fiscal deficit budget utilized until Oct 2018. Key reasons for high fiscal deficit utilization are: a) weak indirect tax collection (down 1% yoy at Rs5.4trn, FYTD19), and b) front loading of expenditure (13% growth in FYTD19 expenditure versus 10% budgeted). If this goes through, it would set a wrong precedent as the reserves are meant for contingency purposes and help facilitate market intervention when needed. This move would not be perceived by markets in right spirit.