The RBI board meets in the midst of government and markets on its guard

MUMBAI (Reuters) – The Reserve Bank of India 's board of directors' meeting kicked off on Monday. Investors were waiting to see whether central bank and government decision-makers could overcome differences on several key issues.

Senior government officials and an independent director have asked the RBI to relax the lending and capital rules of banks, to provide more liquidity to the shadow banking sector, to support small business lending and to let government use more RBI excess reserves to stimulate the economy.

Unhappy with government pressure, RBI deputy governor Viral Acharya warned that undermining the central bank's independence could be "catastrophic".

The public quarrel has suggested that RBI governor Urjit Patel may resign, although the authorities have since sought to curb these talks.

On Monday, the Business Standard newspaper quoted unnamed sources that the RBI could agree at the board meeting to remove some banks from a so-called quick corrective action plan, the government said. being committed to recapitalize them soon.

The corrective action plan resulted in a marked slowdown of lending in 11 state banks.

Until now, financial markets have changed little.

The yield on the 10-year benchmark bonds was 7.81%, compared to 7.82 at the close on Friday, while the Indian rupee rose to 71.89 to the dollar against 71.92 on Friday. The broad NSE equity index has not changed much, to 0.3%.

Investors were on their guard against any resurrection of the conflict between the central bank and government officials, but few expected a firework display, as both sides tried to dispel fears of a more serious attack.

This has left traders still eager to see how the central bank might be willing to compromise to meet government demands.

"Foreign investors will wait for today's meeting to see how central the bank is, but it will be good for the bond markets in the short term if the RBI complies with the government's request for more liquidity" says a broker in a foreign bank.

The council meeting was specially convened to follow up on its last meeting on October 23rd. Otherwise, such meetings rarely attract attention because they are usually devoted to traditional discussions of macroeconomic variables.