RBI’s Autonomy At The Crossroads


By Prof. S.N. Misra

Prof. S.N. Misra

In the RBI’s 83 year history, two Governors have resigned before their terms ended – Sir Osborne Smith (1937) and Sir Benegal Rama Rau (1957). While Smith could not stomach government’s wont to dominate the central bank, Rau resigned due to differences with the then Finance Minister, Mr. T. T. Krishnamachari. As the Reserve Bank board braces up to meet on 19th November to answer a volley of questions from the mandarins of the Finance Ministry, there is an apprehension that the present RBI Governor Mr. Urjit Patel and Mr.Viral  Acharya may resign. This has been further accentuated by the fact that the CIC has issued a show cause notice to the RBI Governor for dishonouring a Supreme Court judgement by not disclosing the list of wilful defaulters. The flash point, however, has been triggered by Mr. Viral Acharya’s address, where he has observed “a government that does not respect central bank’s independence will sooner or later incur the wrath of the market, ignite economic fire and come to rue the day for undermining an important regulatory institution”. He was responding to the three directives sent by the government under Section 7 of the RBI Act; where the Central government can give “such directions to the bank after consultation with the Governor, in public interest”. The Government of India had never used this section so far.

The first issue pertains to keeping weak public sector banks under a ‘corrective action programme’, while the government thinks it is too stringent and needs to be relaxed. Secondly, the RBI in its 12th February has issued a circular that has mandated that ‘a rule based approach’ to be followed for bad load resolution. The government wants it to be diluted. The third issue relates to disentangling ‘payment regulation’ from the purview of RBI, while the RBI feels that payments are a subset of credit regulation. However, the overwhelming reason for the present spat between the government and the RBI is the dictat from the Finance Secretary to the RBI to part with 3.6 lakh crore from its equity of Rs. 10.36 lakh crore, as the government believes that RBI is sitting on excess of capital!

This suggestion was given by Mr. Arvind Subramanian in the Economic Survey of 2016-17, where he noted that “RBI can return as much as four lakh crore to the government, which will help to recapitalize the public sector banks and bring down the twin balance sheet problem”. Rakesh Mohan, a former Deputy Governor of RBI, had strongly disagreed with this suggestion, as he believed that having adequate reserves and capital is important for maintaining fiscal stability of the country. Prof. Viral Acharya during his address in A.D. Shroff Memorial Lecture had observed how Mr. Martin Redrado, Governor of Argentina’s Apex Bank had stepped down after the government had transferred substantial central bank’s reserve to the national treasury. Prof. Raghuram Rajan, the then RBI Governor had also strongly disagreed with CEA’s suggestion, by observing that the government bonds that the RBI was holding has a pristine rating. Any attempt to transfer such assets would only reduce the borrowing power of the government.

The government obviously wants RBI to be accommodative on issues like ‘strict corrective action programme.’ The ratio of NPAs to gross advances has gone upto 22% for Indian Overseas Bank and IDBI, 18% for Central Bank and about 17% of UCO and UBI. In this backdrop the RBI’s insistence to have stricter guidelines than Basel III norms look eminently reasonable. Bank nationalisation (1969) was a watershed moment, when a definite attempt was made to improve penetration of Banks to the small sector and encourage priority sector lending to agricultural sector. This has improved financial inclusion, but triggered the NPA problem. But the major rise in NPAs has been driven by mega power sector projects, steel sector and coal, where apart from delays in land acquisition, the Court judgments is SG and Coal block allocation further queered the pitch of uncertainty.

A perennial question confronting central banking in India today veers around the question as to how much independence a central bank should enjoy. The argument in favour of independent central bank rests on the premise that monetary stability can be best achieved only if the task is entrusted to professional central bankers who can take a long term view of monetary policy. Implicit in this kind of reasoning is the assumption that the political leadership normally tends to take to short term a view. Jawaharlal Nehru in his letter to Governor Rama Rau at the time of his resignation had said “You have laid stress on the autonomy of the Reserve Bank. Certainly it is autonomous but is also subject to central government’s directions. Monetary policy must necessarily depend on the larger policies which a government pursues. It is in the ambit of those larger policies that the Reserve Bank can advise”.

Prof. C. Rangarajan, a former Reserve Bank of India Governor, in his Presidential address to the Indian Economic Association (December, 2017), seems to echo the above sentiments of Mr. Jawaharlal Nehru. Mr. Rangarajan believes that “monetary policy is part of overall economic policy, and any attempt for monetary policy and fiscal policy to run into different direction can be disastrous”. There has to be a close dialogue and coordination between RBI and the government. Mr. Rangarajan believes that in determining the mandate of RBI, the government has complete authority. But once the mandate is given, RBI must be given the freedom to take such actions as it deems fit. He thus makes a distinction between autonomy and independence.

In contrast, Dr. Y.V. Reddy who was the RBI Governor when US financial crisis happened during (2007-08), makes a far more pragmatic view. In his book “Advice and Dissent” he mentions how he had a serious run in with the then Finance Minister P. Chidambaram, when the Finance Minister wanted RBI to reduce the interest rates. Dr. Reddy observes that the autonomy of the RBI has to be seen under three functions viz. operational issues, policy matters, and structural reforms. In the case of the first, he believes that total freedom should be given to the RBI. On the second and third issue, he preferred prior consultation with the North Block and close coordination.

Most of the issues that bedevil the relationship between the government and the RBI now how falls within the domain of operational issues, like regulation of payment and corrective action programme against weak government banks. It may be recalled that the supersession of judges (1973), took place because the Supreme Court judges did not agree toe the line of the government of the day. The judiciary has since than risen to the challenge and asserted its independence and established the concept of ‘basic structure’ which cannot be trampled upon even by a government with brute majority. By invoking Section 7 of RBI Act, the government has invoked its emergency powers the make the RBI toe its line. Sir Osborne Smith, the first RBI Governor had written to the Viceroy that “when the government decides to act against the advice of the Governor under Section 7, it will take responsibility of the action they wish to force on the bank”. Mr. Urjit Patel can profit from the such lessons of professional independence that his predecessors have displayed. There is a saying that ‘rolling loans gather no loss’. Prof. J.K.Balbraith had wittily observed that in India, ‘there is nationalization of loss and privatization of profit’. The time for RBI to stem the rot with professional detachment and firmness has come!


About the author

The author teaches Economics. [email protected], Ph-91-7381109899


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