RBI vs Narendra Modi government: Public spat won’t help, but India’s best bet is not to mess with its central bank

The turf war between the Reserve Bank of India (RBI) and the Narendra Modi government on the subject of the central bank’s autonomy is out in the open and is turning ugly. The fresh round likely began with a speech by one of the four deputy governors in the RBI, Viral Acharya, on Friday night. In his  speech, Acharya made a strong pitch for the central bank’s independence in its core functions and gave nothing short of a lecture on what happens to the economy if the central bank’s autonomy is compromised. Acharya, arguably the most articulate voice in the RBI top brass after Raghuram Rajan, didn’t mince words when he said, “the risks of undermining the central bank’s independence are potentially catastrophic.”

“Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution,” Acharya said.

The warning signals were hard to miss for the targets. The top bureaucrats and political leadership in Delhi’s power corridors duly responded to the central bank’s distress call. According to a Reuters report , the government is ‘very upset’ with Acharya’s public remarks. Union finance minister Arun Jaitley made a tacit counter to Acharya, without taking names, saying regulators should revisit their traditional approach and consult with a wider range of stakeholders. “I think, for any regulatory mechanism, stakeholder consultation has to be of a very high quality, which will probably lead to a revisiting of traditional thoughts and opinions,” Jaitley said at an event organised by the IDFC Bank on Saturday. To be sure, this isn’t the first time that the central bank-government rift has manifested in the public domain. Almost every RBI governor, be it Raghuram Rajan, Y V Reddy or D Subbarao, have pitched for central bank autonomy in public forums inviting the wrath of the government of the day. What are the triggers for Acharya’s tough talk on central bank autonomy now? There were no specific instances mentioned in the speech but the issues aren’t hard to understand. To begin with, the central bank has been citing lack of powers to regulate public sector banks vis-à-vis private banks. This debate intensified after the Nirav Modi fraud at the Punjab National Bank (PNB) came to light and both the government and the RBI began passing the blame on each other for failing to identify the fraud early. The central bank’s attack was headed by governor Urjit Patel while the government retorted saying the RBI has enough powers already for that. [caption id=“attachment_2968016” align=“alignleft” width=“380”]  RBI governor Urjit Patel. Reuters[/caption] The differences in interest rate policy are another area where turf war comes to play. The government has always wanted sharper rate cuts to make money cheaper in the economy while the RBI has taken a conservative approach citing concerns on price stability. Third, early this month, the RBI issued a dissent note on the recommendations of an inter-ministerial committee that the proposed Payments Regulatory Board (PRB) should be an independent regulator. The RBI wasn’t keen for this and said the new body should be under its purview. Also, there were differences between the RBI and the government on the NPA clean up process. There was pressure on RBI from the government to relax the prompt corrective action (PCA) norms which restrict lenders’ activities for having high levels of dud assets and depleting capital reserves. The RBI vs government turf war isn’t new. In fact, the central banks’ powers have been challenged not just by NDA, but also by the previous UPA government also on issues of debt management, banking regulation and monetary policy. Former union finance minister, P Chidambaram had once famously said the government will “walk alone” if need be to support growth when he didn’t get the desired outcome from the RBI monetary policy rate actions at that juncture. In fact, the RBI Act doesn’t give the central bank absolute autonomy. 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. Having said that, it is the duty of a government in a well-functioning democracy to ensure that the central bank is operating with functional autonomy. The simple reason being the central bank, not the government, is the guardian of the economy from the perspective of a foreign investor. If the message that goes abroad from the ongoing turf war is that the government is undermining the autonomy of the central bank, it can prove to be detrimental to the economy.

A sense of uncertainty in the central bank’s independence in dispensing its job can take the confidence away from the investor community, which is not what India wants at this point when the rupee is on a free fall and in the backdrop of a troubled global economy.

It isn’t correct to compare the RBI 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, the 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. India, an emerging, ambitious economy, is in dire need of foreign capital to create industries and offer jobs to millions of new job aspirants thronging the job market every month. If that has to happen, India needs to build confidence in the investor community that it has a functionally independent central bank which fears no political intervention. Already, the demonetisation episode has gifted a reputation loss to the central bank, which remained a passive participant throughout the note ban episode beginning with Modi’s televised statement on 8 November 2016. Immediately after the note ban, Standard & Poor’s Director Kyran Curry said that the move has undermined the RBI’s reputation for competence and independence. The new round of turf war shouldn’t escalate. A public spat wouldn’t help. But, Narendra Modi government’s best bet is not to mess with its central bank in policy matters if it wants meaningful foreign investments when the economy is clearly not out of the woods yet.