n 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 the government’s wont to dominate the central bank, Rau resigned over differences with the then finance minister TT Krishnamachari. As the Reserve Bank board braces for a meeting November 19 to face a volley of questions from finance ministry mandarins, there is apprehension that RBI Governor Urjit Patel may resign. The fact that the CIC has issued a show-cause notice to the RBI governor citing that he has dishonoured the Supreme Court direction by not disclosing the list of wilful defaulters heightens the possibility. The flashpoint, though, was RBI Deputy Governor Viral Acharya’s address in which he observed that “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 before used this section.
The argument favouring 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 long-term view of monetary policy
The issues that provoked the government to issue the directives are substantial. The first pertains to keeping weak Public Sector Banks (PSBs) under Prompt Corrective Action (PCA), which the government finds to be too stringent. Second, the RBI February 12 issued a circular that mandated ‘rule-based approach’ to bad loan resolution. The government wants the circular diluted. The third relates to disentangling ‘payment regulation’ from the RBI’s purview, while the central bank feels payments are a subset of credit regulation. However, the overwhelming reason for the present spat between the government and the RBI seems to be the diktat of the finance secretary to the RBI to part with Rs3.6 lakh crore from its equity, as the government believes the RBI is sitting on excess of capital.
This attempt is a revival of the suggestion Chief Economic Adviser Arvind Subramanian made in the Economic Survey of 2016-17, that “RBI can return as much as Rs4 lakh crore to the government, which will help recapitalise PSBs and bring down the twin balance sheet problem”. Former RBI deputy governor Rakesh Mohan strongly disagreed with the suggestion, as he believed having adequate reserves and capital were important to maintaining fiscal stability.
Raghuram Rajan, the then RBI Governor, had also strongly disagreed with the CEA’s suggestion by observing that government bonds 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 the RBI to be accommodative with PCA. The ratio of NPAs to gross advances has gone up to 22 per cent for Indian Overseas Bank and IDBI, 18 per cent for Central Bank and about 17 per cent for UCO and UBI. Against this backdrop, the RBI’s insistence on guidelines stricter than Basel III norms looks eminently reasonable.
A perennial question with central banking is: How much independence should the central bank enjoy? The argument favouring 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 long-term view of monetary policy.
Implicit in such reasoning is the assumption that political leadership tends to take a short-term view. Jawaharlal Nehru in his letter to Rama Rau when the latter resigned from RBI governorship said: “You have laid stress on 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”.
Professor C Rangarajan, a former RBI governor, in his presidential address to the Indian Economic Association in December 2017, seemed to echo Nehru. He said monetary policy was “part of overall economic policy, and any attempt for monetary policy and fiscal policy to run in different directions can be disastrous”. He believed the government had complete authority in determining the RBI’s mandate. But once the mandate was given, he believed, the RBI must be given the freedom to take such actions as it deems fit.
By contrast, Dr YV Reddy who was RBI Governor during the global recession of 2007-08, took a pragmatic view. In his book ‘Advice and Dissent’ he says how he had a serious run-in with the then finance minister P Chidambaram, when the latter wanted RBI to cut interest rates. Reddy observes that the autonomy of the RBI has to be seen under three functions — operational issues, policy matters and structural reforms. In the case of the first, he believes total freedom should be given to the RBI.
Most issues that bedevil the relationship between the government and the RBI now are operational ones, such as regulation of payment and PCA. The RBI governor must stand firm and exercise professional judgement. It may be recalled that the supersession of Supreme Court judges (1973), took place because they did not toe the line of the government of the day. The judiciary has since risen to the challenge and asserted its independence. In invoking Section 7 of RBI Act, the government has invoked its emergency powers to make RBI toe its line. Sir Osborne, 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”. Patel can look profitably on such history of independence of the RBI. Emasculation of legitimate professional mandate of the RBI must be repulsed, to restore the faith of people and the financial market in the inviolability of our cherished institutional independence.
The writer teaches economics. e-Mail: firstname.lastname@example.org