In 2016, one of the most debated topics was Reserve Bank of India (RBI)’s independence, or lack of it.
The manner in which the exit of former RBI governor Raghuram Rajan happened, the ascension of Urjit Patel to the post of governor in September and the subsequent demonetisation announcement by Prime Minister Narendra Modi in November, gave enough room for Modi critics to cry foul on the rapid deterioration in the central bank’s independence in discharging its functions and government interference in RBI autonomy.
Is RBI an autonomous body in reality?
It is not. According to the RBI Act, 1934, the central bank is answerable to the government. Section 7 of the RBI Act says “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.”
Also, it is illogical to think that an institution like RBI, whose head is appointed by the elected government, not Parliament or by the people, can act completely independent of the ruling political dispensation.
So what’s the big fuss about the RBI’s autonomy?
The RBI can’t be treated at par with other sector regulators such as Securities and Exchange Board of India (Sebi), Insurance Development and Regulatory Authority (IRDA), Pension Funds Regulatory and Development Authority (PFRDA), whose roles are rather limited to certain specific areas. Compared to these institutions, the RBI has a much bigger profile on matters related to the broader economy.
As former RBI governor Y V Reddy said in one of his recent interviews, monetary policy is one of the many functions of the RBI. The others include the government’s debt management, banking sector regulation and supervision, currency management and more importantly, managing price stability in the economy, thus guarding the credibility of the financial system.
Why we need RBI? Can’t the government, the people-elected body, undertake this function? This could have been possible, but the political dispensations always tend to have short-term, pro-growth view on the economy rather than long-term financial stability. Also, the governments are prone to use the banking system to push their populist objectives in order to appease the vote bank, even though the action may not be in the good interest of the banking system (examples are loan waivers and calls to restructure loans). These are the reasons why a foreigner who looks at India attaches more value to the guidance and caution from the RBI than a minister.
This is perhaps the reason why a clutch of former RBI officials, including Reddy, Manmohan Singh, Bimal Jalan have pitched for the independence in the operations of central bank. In the aftermath of note ban, this chorus has grown louder. Reddy, in an interview, complained of erosion in the central bank’s autonomy and a threat to its hard-won reputation over years.
In an interview to CNBC-TV 18 (read here), Reddy said. “I would even go to the extent of saying that particularly recent events, I have seen the comments from economists, from Standard & Poor’s and they are disturbing. For the RBI, for a central bank, reputational risk is the worst risk. Credibility is the worst risk. And if this is happening in the international opinion, I would say that it is a national problem now and it is not just a political issue,” Reddy said.
Jalan, too cautioned about the autonomy, in an interview to CNBC-TV 18. “The autonomy of the RBI — that is a very fundamental fact and we have to maintain it and I hope the government would give attention to that part also,” Jalan said.
Not just NDA Vs RBI
Though the issue of RBI autonomy came under greater public scrutiny during the Narendra Modi government's regime that came to power in May 2014, particularly after the Raghuram Rajan episode and RBI’s role in managing the demonetisation exercise, the fact is that the RBI-government autonomy debate is not a new development.
It is well known that the government always put pressure on the RBI to push interest rates down to support growth, leading to open conflicts. At a larger level, the process of cutting the RBI’s wings began way back during the UPA days, especially when the Financial Sector Legislative Reforms Committee (FSLRC) had recommended taking away the debt management from the central bank to a separate entity, public debt management agency (PDMA) and creating a super regulator and shifting the power to set interest rates from the governor to a monetary policy committee (MPC).
While both the proposals — creation of PDMA and MPC — have been welcomed largely to improve the existing framework and avoid conflict of interest, the plan to create a super regulator has been discarded outright. Rajan called it ‘“somewhat schizophrenic”. The process of further weakening the central bank continued during the NDA regime, when the government failed to fill the posts of a number of non-official directors on the board of the RBI (read here) at a time when the central bank was engaged in a credibility fight struggling to manage the massive demonetisation exercise in Asia’s third largest economy.
In hindsight, thus, the RBI’s powers have already been cut down significantly or the process is on.
Demonetisation episode has raised further questions on central bank’s authority in the currency management as well, but the finer details will only emerge when the finer details of the thought process that led to demonetisation will be made public. Former RBI deputy governor, K C Chakrabarty, in this interview, said that the central bank, in the past, was not keen for demonetisation. “In the past, RBI has been uncomfortable with it, as rough estimates suggest only 6 percent to 8 percent of black money is in cash. And it does not make sense to hurt 90 percent people, especially the poor and underprivileged, for such a small percentage of black money,” Chakrabarty said.
“It is like bombing a building with 200 people to kill five terrorists. Also, the people with money have more clout. They can hide black money in many other ways. Ultimately, the poor and underprivileged suffer,” the former deputy governor said in the interview.
The point is, no government would have wanted a central bank absolutely independent in functions, but the central banks across the world continued to enjoy a level of autonomy in their operations. As former FM P Chidambaram writes in this column the power offered by Section 7 has never been exercised in the 83 years of the RBI Act.
A Mint article points out that the RBI has been one of the least independent central banks in the world. As this report argues, the current debate on the RBI's autonomy shouldn’t be confined to monetary policy but larger issues.
A toothless, weakened central bank wouldn’t do any good for any aspiring economy like India, which is somewhat the situation at this stage. The global investors and economy watchers will then look at the country with an element of skepticism. Rating agencies have issued caution on a growing trust deficit in India when RBI’s autonomy is curbed and have noted that note ban has hurt confidence in the central bank (read here and here). No one doubts the Modi government’s intention to clean up the economy and making an attempt using demonetisation as a tool to achieve that objective. But, this government would do well taking note of the warnings signals and stay at an arm’s length from the Mint Road.
Updated Date: Jan 20, 2017 14:49 PM