Govt shouldn’t see RBI as its subordinate

It is barely two years since Urjit Patel took charge as Governor of the Reserve Bank of India. Viral Acharya, the Deputy Governor, has spent even less time in his post. The appointments came soon after the exit of Raghuram Rajan, whose term as Governor was not extended amid an unseemly row whipped up by political players.

After that unhappy exit, one presumes that the government took a careful call on picking the new team at such an important institution. Why is it then that relations between the government and the RBI have dipped to a new low so soon, and so suddenly? The truth is that the issues, particularly those concerning the autonomy of the RBI, have been boiling for a while now.

As regards monetary policy, the introduction of inflation targeting and constitution of the Monetary Policy Committee (MPC) are classic cases of effective and efficient government and central bank interface. Similarly, the abolition of automatic monetisation, implying RBI financing the deficit of the government and the introduction of the Fiscal Responsibility and Budget Management (FRBM) Act again are landmark decisions jointly taken by the RBI and the government, strengthening the RBI independence.

Thought-provoking

So, the much spoken of speech, ‘On the Importance of Independent Regulatory Institution – The Case of the Central Bank’, by Acharya is a culmination of a host of issues that are summed up in there. The speech is not only erudite in content but also thought-provoking in many ways. When the definitive history of the RBI in general and autonomy of RBI in particular will be written, these words will be regarded as the locus classicus on the subject under reference.

The content of the speech has aroused unprecedented media response and the common coming out in various fora is that RBI as a regulator has raised its voice against government interference in its autonomy. However, a critical study of Acharya’s speech reveals that he has also spoken for the restoration of RBI autonomy and built a strong and positive case for RBI independence in three important areas — monetary policy, debt management, and exchange rate management.

As regards monetary policy, the introduction of inflation targeting and constitution of the Monetary Policy Committee (MPC) are classic cases of effective and efficient government and central bank interface. Similarly, the abolition of automatic monetisation, implying RBI financing the deficit of the government and the introduction of the Fiscal Responsibility and Budget Management (FRBM) Act again are landmark decisions jointly taken by the RBI and the government, strengthening the RBI independence. The decision of the government to keep the desired exchange rate management with the RBI is another example of strong and positive example for building central bank autonomy.

Regulation of PSBs

The vexed problem of breaking down of the RBI autonomy is associated with, as Acharya pointed out, the context of regulation of public sector banks, absence of rules of transfer of surpluses from the RBI to government and recommendations to bypass the RBI’s powers over payment and settlement systems.

The RBI performs several functions as a central bank; it is the monetary authority, banker to the government, debt manager to the government, monopoly issuer of legal tender currency, the custodian of payment systems and above all the regulator of banks. All these functions are critical for growth, macroeconomic stability and financial stability.

In all the functions cited above, in the regulation of banks, particularly public sector banks, the RBI faces constraints in the regulatory framework as well as in implementation of the regulatory decisions. These limitations are manifested in the asset divestiture, replacement of management and boards, licence revocation and resolution actions such as merger or sales.

YV Reddy, a former Governor, in the context of central bank autonomy, observed that, “My single objective is to protect the Indian economy from the Government of India.” Reddy has also noted that “the jurisdiction of the RBI over public sector banks, relative to private sector banks, has been restricted by law. The exercise of regulatory authority is constrained in practice.”

While narrating this, Acharya, by and large, reiterated what Governor Patel said in his landmark speech of March 2018, titled ‘Banking Regulatory Powers should be Ownership Neutral’. In this context, it is interesting as well as instructive to refer to another important speech by Acharya on October 12, titled ‘Prompt Corrective Action: An Essential Element of Financial Stability Framework’.

This speech, as reported in various fora, is in response to the clamour for the government to dilute the risk threshold set out by the RBI in various indicators. Time and again, the RBI has insisted on Prompt Corrective Action (PCA) as a well proven regulatory framework and an accepted benchmark for ensuring a healthy banking system in the context of long-term interest of growth, macroeconomic stability and financial stability.

It will be in the fitness of things to state that the content of Acharya’s speech is the voice of the RBI which summarises, “Governments that do not respect central bank independence will sooner or later incur wrath of financial markets, ignite economic fire and come to rue the day they undermined an important regulatory institutions; their wiser counterparts who invest in central bank independence will enjoy lower cost of borrowing, the love of international investors, and longer life spans.”

Suggestions and reports that the government will invoke or has already invoked the so far never-used Section 7 of the RBI Act 1934, in which it will issue an order to the RBI to take into account the government instructions in the public interest, only add to the confusion and make the problem worse. The government statement of October 31 in fact reiterates that while the government respects the autonomy of the central bank, this will “have to be guided by public interest and the requirements of the Indian economy.”

Pitching for autonomy

The autonomy of the central bank has not been debated for the first time in the Indian context, governor after governor has raised this issue. YV Reddy, a former Governor, in the context of central bank autonomy, observed that, “My single objective is to protect the Indian economy from the Government of India.” Reddy has also noted that “the jurisdiction of the RBI over public sector banks, relative to private sector banks, has been restricted by law. The exercise of regulatory authority is constrained in practice.” And in this context, he adds: “A central bank is not expected to be subordinate to the government.”

Government, as a political entity, needs advice which is in the best interest of sustaining growth, maintaining macroeconomic stability and financial stability. More than 80 years of RBI history is witness to the fact that the RBI is the right organisation to advise the government in this regard. Let the government not treat the RBI as its subordinate.

Rajan has also offered a similar voice: “India needs a strong and independent RBI to ensure macroeconomic stability”. Former Governor D Subbarao’s famous statement, “But thank God, the Reserve Bank exists”, is another classic example of the voice of the RBI for central bank independence and autonomy.

Government, by the nature of its functions and limited by tenure, is a prisoner of the argument that the RBI is like any other regulator and subordinate to government. But, as Rajan has pointed out, “The RBI Governor, as the technocrat with responsibility for the nation’s economic risk management, is not simply another bureaucrat or regulator, and efforts to belittle the position by bringing regulatory hierarchy are misguided and do not serve national interest.”

Government, as a political entity, needs advice which is in the best interest of sustaining growth, maintaining macroeconomic stability and financial stability. More than 80 years of RBI history is witness to the fact that the RBI is the right organisation to advise the government in this regard. Let the government not treat the RBI as its subordinate.

The trouble is the government tends to believe that just because it picked its candidates, they will sing its tunes. Reality is that the culture of the RBI, which this author can say for sure, is one of fierce independence and in support of policies that the RBI believes are in the long-term interest of the nation.

(The writer is a former central banker and faculty member at SPJIMR.)