There is a deluge of expert and academic opinion on the current Reserve Bank of India (RBI)- Government 'confrontation'. Are things as scary as they are made out to be? Is it possible to take a more commonsense view on the goings on?
The heat being generated is somewhat mystifying. Because, on the face of it, there seems to have been a noticeable expansion and strengthening of the institutional position of the RBI over the last four years, in at least two significant areas.
What are these two areas? The first area is that of monetary policy, and the step forward has been the establishment of a Monetary Policy Committee (MPC) in 2016. The MPC has been given a clear mandate of inflation targeting. The MPC has an equal number of nominees from both the Reserve Bank and the government.
Notably, the three government nominees are not from official circles, but all experts and academicians of standing. This is a big reform, which has strengthened the institution.
How is this so? Till the setting up of the MPC, it was the governor of the RBI who had the sole responsibility for setting of policy on interest rates, based on his best technical assessment of what was suitable.
Historically, finance ministers have sought to accelerate growth and boost credit, while governors have prioritised stability and control of inflation. Accordingly, successive finance ministers have sought a more relaxed interest rate regime than most governors thought appropriate. This used to be a recurrent source of much of the friction between the Ministry and the RBI.
Now, this front has cooled down. The government has set an inflation target of 4 percent (+/-2 percent)and the MPC decides what policy measures are needed to achieve the mandated inflation target.
The RBI’s hands are strengthened as a result, because, based on it’s technical inputs, it is now the committee that decides policy rates, and not the governor alone. This reduces the direct pressures on the governor. Further, the committee acts to achieve an objective transparently laid down by the government.
How has the MPC performed? In the two years since the MPC started functioning, inflation has remained within the target range. A welcome sign of stability from the days of highly fluctuating rates – it had touched 12 percent in 2013-14! Hopefully this can be kept up.
The second major area relates to the banking supervision role of the RBI, and the step forward has been the Insolvency and Bankruptcy Code (IBC) 2017 and the associated bankruptcy regime. We all know now that Non-Performing Assets/NPAs (simply put, bad loans) of banks had been building up over the years, particularly from public sector banks.
Pre-IBC, big borrowers (including defaulting big borrowers) seemed to call the shots, and the banks seemed helpless to recover loans in the face of their money and political power. The RBI was supposed to check this. It has a systemic role as the banking regulator.
The RBI also has a more direct role as a member on the board of the banks. On the face of it, it does seem that RBI was less than active in this matter. The situation has deteriorated to a point where RBI figures acknowledge that the NPAs of the banking system are now over Rs 10 lakh crores (90 percent of it in public sector banks).
The new IBC regime formally enables the creditors, and not the borrowers, to call the shots in deciding what to do with defaulting companies. It also puts in place a time-bound process for the resolution of bad loans, as well for the next steps, that is, bankruptcy and sale proceedings. It has already shaken up big industrial groups who are losing control of business empires built on dodgy foundations. It’s a big step in the right direction.
With the statutory backing of IBC, the RBI is now enthusiastically cracking the whip, and taking its supervisory role in earnest. Indeed, it kicked off the process by requiring commercial banks to refer the cases of 12 specified biggest defaulters for resolution under the IBC framework. Now it has issued strict guidelines to banks on the referring of such cases and set out the criteria and timelines. The RBI is pushing banks to comply with the existing Prompt Corrective Action (PCA) framework designed to prevent banks from getting into such a critical situation!
Now, how do these initiatives affect the key players? The government has done quite a bit in the last few years to strengthen the hands of the RBI. If I were the government, I should be happy to see these initiatives move in the right direction and yield tangible outcomes for the economy – whether in terms of control of inflation, or sorting out the lax lending practices leading to NPAs.
If I were the RBI, I should also be more than happy with these initiatives, which have buttressed the institution and activated the role of the central bank. And if I were the common man (as I am!), I should be happy to see for the first time a government clearly targeting inflation, which disproportionately hits the poor and the unorganised. I would also derive some satisfaction from the visible efforts now being made in the banking system to bring to book the rich borrowers who have been playing around with the money of the poor depositors.
From a commonsense point of view, there are many reasons for everyone to be happy. But, if we go by the discourse in the media and the scholarly articles on the subject, everyone currently seems to be unhappy on what’s happening with the government and the RBI. Reportedly, there are now three further proposals of the government that “threaten the independence” of the central bank.
The optics are terrible. A recent speech by RBI Deputy Governor Viral Acharya at a public forum on 26 October 2018 suggests that something is seriously wrong. To quote: “Governments that do not respect central bank independence will sooner or later incur the wrath of the financial markets, ignite economic fire and come to rue the day they undermined an important regulatory institution.”
Now, for a top RBI official, this is unusual. Central bankers are meant to reassure the markets and the public, and prevent panic. They reassure when they are calm and measured in tone and opinion, relying on facts, technical analysis and reasoning to present a viewpoint or decision. Is 'independence' in danger from the government, and are things really so bad and so unprecedented?
It is said that three proposals of the government are the issues of contention, and threaten the independence of the central bank. These issues reportedly relate to the norms for deployment of the capital reserves of the Bank, special dispensations in the prompt corrective action framework for advances to stressed power companies, easing constraints on lending to small and medium enterprises. I am not going into the merits of these so-called issues of contention.
Let’s face it. Governments of the day will always push for what they believe are pro-growth, pro-people measures. Central banks, charged with ensuring monetary stability, may not always agree with these measures. Such differences have always been there in the past, and will inevitably be there in the future. The “independence of the central bank being in danger” is always a key negotiating chip in discussions on such differences!
Looking back to 2008, recall the well-publicised differences between former finance minister Chidambaram and one of the most seasoned and balanced Reserve Bank Governors Y V Reddy over the foreign ownership of banks. It was resolved, like most such differences in the past, and the system moved on. The same finance minister had issues with the next governor D Subbarao as well. It’s not unusual. Governors attempt to address the concerns of finance ministers, or convince them otherwise, in the light of their best professional judgment and institutional mandate.
In rare cases, things don’t work out. Looking further back to 1957, then RBI Governor B Rama Rau could not come to terms with the alleged interference in monetary policy of finance minister T T Krishnamachari (TTK). Matters came to a head,and TTK got the backing of Prime Minister Nehru. Governor Rama Rau resigned. There was then too an outcry that this was an assault on the independence of the Bank. Sixty years on, the central bank continues to be a solid institution. Since there is again a clamour that its independence is in danger, I suppose it means that independence still exists!
From the recent track record, there just doesn’t seem to be any good reason to suspect a diabolical plot to undermine the RBI, when the government has on its own already done quite a substantial bit to strengthen the institution. Given this record, the RBI governor’s job should be to engage with the government on its concerns, and try to find workable solutions within the central bank’s institutional mandate, relying on his institution’s technical expertise and economic reasoning to make his case. Though the media barrage doesn’t suggest so, I would imagine that behind the scenes, this is precisely what is being done.
Rest assured that whatever the final decisions on the contentious issues, the heavens will not fall! Ministers and Governors may come and go, but the RBI is a sound and robust institution. The RBI will continue to be as independent as it needs be. It has weathered many such storms in the past, and emerged stronger and better equipped to the meet the challenges of the times every time. There is no reason to suppose that this time would be any different.
Updated Date: Nov 19, 2018 08:08 AM