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How independent is RBI?

How independent is RBI?
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First Published: Wed, Jun 16 2010. 11 14 AM IST
Updated: Wed, Jun 16 2010. 11 14 AM IST
New Delhi: Stubbornly high inflation is putting pressure on the Reserve Bank of India to raise interest rates ahead of a scheduled July review, and the finance minister is seen to be slowly coming around to the view.
Many analysts now see a rate hike before 27 July after data showed May headline inflation unexpectedly accelerated and with signs of rising price pressures from strong demand in Asia’s third largest economy.
Finance minister Pranab Mukherjee on Monday said he did not favour raising rates, noting inflationary pressures would ease from mid-July. A day later, Mukherjee said RBI would take appropriate steps to control inflation as and when needed.
Here are some questions and answers about the independence of the RBI.
What does the law say?
The RBI is not constitutionally independent, as the 1934 act governing its operation gives the government power to direct it. The government appoints the central bank governor and four deputies.
“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,” the act says.
Technically, the government is also permitted by the Act to supersede the central bank if it believes the RBI has failed to carry out its obligations.
What happens in practice?
Over the last quarter century, the RBI has been seen to be more independent as India’s economy has liberalised, although much consultation takes place between the central bank and the finance ministry, and the government has been known to exert its will, against the wishes of the RBI chief.
“There is no legal act mandating autonomy of the RBI, but there is a growing convention that the RBI is allowed autonomy to do what it wants,” said Shankar Acharya, an economist with New Delhi-based think tank ICRIER and a former chief economic adviser to the government.
Consultations between the RBI and the finance ministry, which Acharya described as “substantive,” are not unusual in India.
Is “consult” just a polite word for “government order”?
Not necessarily. The RBI and government have clashed over monetary policy in the past, notably during the tenure of the previous governor, Y.V. Reddy, and then-finance minister Palaniappan Chidambaram.
In 2007, global interest rates were softening but the central bank under Reddy maintained a hawkish stance, citing inflationary risks stemming from high oil prices. The government favoured lower interest rates to help sustain high growth and bring relief to borrowers.
The RBI’s view prevailed and it hiked policy rates. In June of the following year, however, Reddy was prodded by the finance ministry to raise rates against his wishes, he revealed in an interview after he left office.
But generally, the finance ministry and the RBI try to find common ground on issues concerning monetary policy.
So what governs the RBI’s independence?
Personalities to a very large extent. Reddy, for example, was “fiercely independent”, according to Surjit Bhalla, head of Oxus Investments in New Delhi.
Subbarao is seen as more open to consultations with the finance ministry, although he has demonstrated independence with criticism of the government’s fiscal deficit and early warnings on inflation.
What other influence can the government have?
Appointments. The government appointed Subbarao, who was the top bureaucrat in the finance ministry, as central bank governor, bypassing Reddy’s deputy Rakesh Mohan, who had been seen as a strong candidate.
This was a rare instance where the top bureaucrat in the finance ministry was appointed to the top job at the Indian central bank immediately after serving out his stint as finance secretary.
The government can also issue directives on non-monetary policy matters such as foreign investment rules in the banks.
Who should investors be watching for policy clues?
Both the government and the central bank. Top officials, including the finance minister, Prime Minister Manmohan Singh, and Planning Commission deputy chairman Montek Singh Ahluwalia speak frequently on matters of monetary policy, and their views influence policy decisions.
It is Subbarao, however, who decides the timing, means, and degree of policy moves. “It’s kept grey,” said Acharya. “Fortunately, there is growing convention for autonomy. I don’t think the RBI is being dictated to.”
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First Published: Wed, Jun 16 2010. 11 14 AM IST