Photo: Aniruddha Chowdhury/Mint
Photo: Aniruddha Chowdhury/Mint

Opinion | RBI’s independence needs to be protected

Its rock solid reputation has been built over a long period of testing times that needed tough decisions

The relationship between the government and the Reserve Bank of India (RBI) used to be cooperative and productive, but has vitiated over the past decade. These depredations have impacted the functioning of the top management of the RBI and has diluted the morale down the line." These are the words of a former deputy governor of the RBI, written just three weeks ago in the Business Standard. In that same piece, Rakesh Mohan also wrote that the RBI and the government are increasingly seen functioning as adversaries. This impression should be corrected. Public airing of differences must be eschewed and the government must take steps to strengthen RBI’s independence. Indeed their contentious discussions must take place in an atmosphere of mutual trust and respect.

This piece by Mohan, uttered in a low key and genteel voice, says something very similar to the much more forceful speech of deputy governor Viral Acharya two weeks later. However, the latter seems to have stirred the hornet’s nest. Its articulation of the need for central bank independence is both masterful and scholarly. It should be read in its entirety. However, by using examples (and implicitly drawing parallels) of cases such as Argentina, which had a financial and constitutional crisis, he may have upset some mandarins of North Block. He also warned that governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire and rue the day they undermined the institution’s autonomy. The way the stock market and the exchange reacted on Monday gave some credence to his dire warning.

The main problem is that once the discourse spills over into the public, nobody can control it. Positions harden quickly and the debate is of the “either you are with us or against us" variety. This is the antithesis of the basic issue, which is essentially about deciding on shades of grey. That is why Mohan and many others have advocated keeping the discussion, dissent and debate away from the public eye. One can only assume that matters reached a point of extreme provocation and that is why it spilled over.

Viral Acharya’s articulation of the need for central bank independence is masterful and scholarly -

For instance, RBI has been very clear about its 12 February circular. It had wound up all its earlier schemes of loan restructuring in light of the new Insolvency and Bankruptcy Code (IBC). RBI’s new paradigm is clean and transparent and quite flexible to banks for restructuring stressed loans. If restructuring is not possible within 180 days, banks have to automatically put the non-performing loan into the IBC process. Under the new IBC regime, RBI has no need or business to specify a separate scheme for restructuring stressed loans. The time limit of 180 days is strict to encourage a strong credit culture, and prevent banks from resorting to their bad old ways of “kicking the can" or “extend and pretend". That culture created incentives for both borrowers and lenders to go to great lengths to avoid the non-performing asset tag. However, RBI has been under tremendous pressure, including through lawsuits, to dilute its stand and give relief, especially to the power sector. Who is to say that if one sector gets relief today, telecom or airlines won’t ask for it tomorrow? Besides, if the power sector needs help, it should come from fiscal resources, not by diluting the hard won framework to strengthen credit discipline. Is RBI not being pragmatic? Or is it being bullied too much?

Another recent instance was about diluting the prompt corrective action (PCA) under which 11 public sector banks have been restrained from issuing fresh loans. A third was about opening a liquidity window for non-bank financial companies in light of the turmoil created by the bankruptcy of Infrastructure Leasing & Financial Services. Both of these are worth debating and discussing, but away from the public eye. If, in the present context, RBI’s considered view is that there is no need to dilute PCA or there is no systemic danger to liquidity, it must be respected. It does not mean an end to consultations, or that fresh evidence not be presented continuously.

RBI was set up 12 years before India’s independence. In the eight decades of its existence, it has distinguished itself with conduct of the highest standards. It is among a handful of national institutions known for exemplary integrity and incorruptibility. Of course, it may have had its share of bad apples and it may have committed policy mistakes (known only in hindsight). However, overall, its rock solid reputation has been built over a long period of testing times that needed tough decisions. This reputation and credibility are its most precious, yet fragile, assets. The main reason for central banks’ independence is that governments are much more myopic, as political considerations are often short term. Thus, they may push up fiscal spending to boost growth in the near term, or may pressurize to keep interest rates low to keep borrowing costs low, or may prefer to be lenient about loan recovery. These actions may be because of electoral compulsions, or simply political short-termism. However, the medium or long term costs, in terms of inflation or recession and financial instability, may be enormous.

Finally, let’s remember that two and half of the four pillars of democracy, are not elected by the voting public, and are yet crucial to its robust functioning. These are the judiciary, the press and the unelected bureaucracy. Accountability is not only about the ballot box. All citizens, elected or not, have a responsibility of eternal vigilance.

Ajit Ranade is an economist and senior fellow, Takshashila Institution.

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