Here’s some terminology you are going to be hearing a lot about in the coming days:
NBFC: a Non Banking Financial Company. This is a company that can provide some financial services, such as lending money to other businesses. It is not a bank as it is not allowed to take deposits from people. So you and I can’t deposit our money in a NBFC and collect interest on it.
How do NBFCs get the money that they lend to others? They themselves borrow money from banks, then give loans at higher rates for various projects and then return the money to the banks. Or then there are mutual funds or other such investors who give them money in exchange for an investment.
RBI: This is the Reserve Bank of India. It is the central bank of India. What does it do? It puts policies in place to balance various important metrics, such as the price of the rupee, inflation rates (how much the price of goods increase or decrease), and interest rates (what kind of return you can get if you deposit your money in a savings account for instance), amongst other things. This is independent of the government.
Fiscal Deficit: Because the government has so much to spend on, its expenditures are typically higher than the taxes it collects. This is called a “fiscal deficit”. This is the extra amount the government must borrow from banks and others to fund its expenditures.
Fiscal Deficit is when Expenditure > Income. The opposite of a Fiscal Deficit is Fiscal Surplus, where Income > Expenditure.
Urjit Patel: Urjit Patel was the Governor or head of the Reserve Bank of India, until earlier this week, when he resigned from his position.
What’s going on? Was this expected? Urjit Patel would have completed his 3 year term in September 2019, so this was not expected.
Why dd he resign and why is this a big deal?
India has a pretty sizeable deficit. We are spending more than we earn. The Banks are not doing too well for a few reasons:
- the loans that they have made to companies are not being repaid (these companies are called Non Performing Assets or NPAs, which we had discussed a while ago while discussing Punjab National Bank).
- or they have borrowed money from the Banks for 6 months or a year, but have loaned out the money to companies for a longer period. So if the Banks want their money back and do not renew the loans they have made to the NBFC, the NBFCs are not able to repay the loan.
While the Bank NPA problem was known for some time, now the NBFCs are also not doing well at all. So both the Banks and the NBFCs are unable to provide money for infrastructure development or to fund small and medium businesses. This situation has led to a “liquidity crisis” in the country, where businesses are unable to get money to fund their operations. This will lead to the economy slowing down.
All of this has been bothering the government and everyone is pretty eager to make things better. The RBI has been doing what it thinks is right by controlling inflation and by demanding that Banks and NBFCs need to become much stronger before they are allowed to lend the amount of money that they have been until of now. It has not agreed with the government on some important things, for example, the government wants the RBI to enable the NBFCs to continue to finance their customers. The government also wants the RBI to give it some money for various issues that the government wants to help out with. The RBI has not agreed with the government on some of these important issues.
Got it. So what happened with Urjit Patel? A month ago, there was talk that the government was going to invoke a clause called Section 7 of the RBI act. Invoking Section 7 of the RBI Act would mean that the government could apply pressure on the RBI to do what it wants. This is a clause that has never been exercised before, and it made people very wary as this means that the government wants to do away with the independence of an entity that is very important.
It isn’t known what exactly happened to make Urjit Patel resign, but it’s probably safe to say that he was not in favour of the government interfering with the policies of the RBI.
What does this mean for us? This kind of uncertainty for India is not great, and can spook foreign investors who have already been pulling money out of India to invest in what they think are more stable markets. The government has just announced that its ally Shaktikanta Das will take over the position of the Governor of the RBI. There is worry that the government will continue trying to strong arm this independent institution. All this ahead of a very big election year in 2019 means that there is a lot at stake.