An avoidable path

Last week, Viral Acharya, deputy governor of the Reserve Bank of India (RBI), gave a rather alarming speech in Mumbai. In the speech, widely seen to have the blessings of RBI Governor Urjit Patel, Mr Acharya argued that when governments undermined the central bank’s independence they scored an own goal of sorts because doing so triggered a crisis of confidence in capital markets, which are, in turn, tapped by governments (and others in the economy). Mr Acharya explained how the decision-making approach of a central bank was starkly different from that of a popularly elected government. Using a cricketing analogy, Mr Acharya argued that while a government’s horizon of decision making was akin to playing a T-20 game, where quick delivery on promises is of utmost importance regardless of the long-term adverse consequences, a central bank played a Test match, trying to win each session but importantly also surviving it so as to have a chance to win the next session.

While accepting that over the decades, the RBI has been made more independent and given more autonomy, towards the second half of the speech, Mr Acharya elaborated on some of the issues that continue to mar the RBI’s relations with the government. The key issue among them pertains to the statutory limits in regulating public sector banks (PSBs). In particular, the RBI has little power over PSBs when it comes to dismissing board members, or mergers or indeed licence revocation — areas where it calls the shots in relation to private sector banks. Another thorny issue relates to the transfer of excess reserves from the RBI to the government. While the government wants these funds to cover its expenditure, the RBI has been resisting it for the sake of financial stability of the system. Lastly, there is growing disagreement between the RBI and the government when it comes to the regulatory scope of the central bank. The government’s proposal to put in place a new and separate regulator for payments systems, taking it out of the RBI’s purview, is a case in point. Such concerns need to be addressed by the government.

It is also true that the RBI-government relations have been far from smooth for a while now. But while the principle of a central bank’s independence is of utmost importance and not something that any government should violate, it is not as if the government doesn't have its side of the story. The government complains of the RBI’s intransigence in understanding the public policy challenges that result because of the regulator’s stand. For instance, while the RBI allowed regulatory forbearance to PSBs on NPAs since 2008, it has now placed much stricter demands on asset quality than even the international norms. But the government argues that PSBs will not be able to meet such onerous targets all of a sudden. Similarly, with regard to prompt corrective action (PCA) in some PSBs, the RBI's action could lead to some branches shutting down. But what happens to financial inclusion, asks the government, which after all represents the people, who are the ultimate sovereign. There are no easy answers here but surely a public display of disaffection will help the credibility of neither. History suggests that the government-RBI team delivers the best when it functions like a joint family: Disagree internally if you must and resolve the thorny issues through consultation, but present a united front to the outside world.

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