Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Opinion | A thin line divides RBI autonomy, alignment

The past decade's steady sound of the government chipping away at RBI's powers and autonomy has now reached a crescendo

The tawdry, and discreditable, public feud between the government and the Reserve Bank of India (RBI) seems to indicate that, in the midst of many shortages, the government is hoarding reserves of surplus political capital. Governments usually pick their battles carefully, especially before crucial elections. In choosing to publicly lock horns with the central bank, the government is sending out differentiated messages to varied audiences, ranging from investors to banks, savers to borrowers, civil society to political operatives. But, in doing so, the government also risks running down its reserves of trust, goodwill and influence. Political capital is somewhat like cryptocurrency, non-physical and invisible but ephemeral and volatile when put to speculative use.

RBI’s scheduled board meeting on 19 November has been preceded by frenzied public posturing, with the government indulging in calculated, and occasionally indiscreet, leaks to the media. Things must have gone terribly wrong and relations deteriorated irreconcilably for the government to situate a routine central bank board meeting squarely in the piazza of public opinion. Tension between the government and the central bank is healthy, but the past decade’s steady sound of the government chipping away at RBI’s powers and autonomy has now reached a crescendo.

The government’s current surge of ire is the accumulation of several RBI steps: the 12 February circular which redefines loan defaults; prompt corrective action against 11 public sector banks that circumscribes their ability to expand loan books; refusal to heed government entreaties to open a liquidity window for beleaguered non-banking financial companies (including, as an RBI board member suggested blithely, by printing excess currency); relaxing Basel-plus capital adequacy norms, among others. Thwarted by RBI intransigence, the government pressed the nuclear button: it threatened to invoke section 7 of the RBI Act, which gives the government powers to dictate to the central bank, including appropriating the central bank’s reserves. This, in turn, provoked deputy governor Viral Acharya to deliver a sharp critique, presumably with governor Urjit Patel’s imprimatur.

Frictions between the government and RBI have got magnified in the decade after the global financial crisis. Tell-all books from former governors Y.V. Reddy and D. Subbarao describe in detail how pressure was exerted to keep interest rates low and monetary policy accommodative, even as asset-price inflation threatened financial stability and structural deficiencies drove up the price line to almost double digits. The seeds of corporate overleveraging and ballooning of bad loans were largely sown during this period. Ironically, the government now blames RBI for this loan gluttony and resultant indigestion. It is also during this period that the government used its legislative powers to amend the RBI Act to nominate an additional bureaucrat to the central bank’s board, or to create a super-regulatory body in an attempt to diminish RBI’s primus inter pares status among regulators.

The government’s increasing demands on the central bank can be viewed in two ways. One, as a spectacle of rising desperation on the eve of the general election as the promised economic well-being eludes ordinary Indians, especially after the misguided demonetization move. The other way to see it is through the lens of expectations: have RBI’s past actions given the executive reason to expect more? The central bank’s role in demonetization was questioned in several quarters and the governors are yet to explain their stand or address the lingering questions. The larger question is whether the new monetary policy, based on the single objective of inflation-targeting when compared with the earlier framework of multiple indicator approach, has provided the government with the necessary ammunition to push the envelope. Existing literature shows how inflation-targeting in the absence of necessary sufficient conditions can be premature. For example, the problems of inadequate monetary policy transmission, highlighted by RBI’s own internal study group (sluggish and excessively lagged, asymmetric across borrowers and monetary policy cycles), should have stayed the central bank’s hands. Then there are other infirmities—underdeveloped financial markets, persisting structural problems, weak macro fundamentals (deficit pressures)—that ideally should have delayed the implementation of an inflation-targeting regime. To its credit, the monetary policy framework has certainly contributed to the current benign inflation regime, but then so have a combination of other serendipitous factors, such as low oil or food prices.

In the balance of political expediency versus central bank autonomy, there is a view that implementing inflation-targeting perhaps adds more to political capital rather than comprehensively furthering the cause of central bank autonomy. Even in the binary choices between price stability and growth, both of which form RBI’s stated objectives, the central bank is expected to walk that fine line between autonomy and alignment with the government’s growth objectives. This includes pursuing greater transparency and implementing robust communication policies. The government, on the other hand, needs to appreciate the central bank’s expertise and its deft handling of earlier crises while refraining from interfering in the policymaking and rate-setting process. That should set the tone for the board meeting, where mutual appreciation and understanding triumph transient and partisan interests.

How should the government and the central bank resolve their differences? Tell us at views@livemint.com

Close