RBI’s Autonomy Is Under Threat, And It’s A Bad Sign For The Indian Economy

Narendra Modi on his Twitter account lauded Dr. Urjit Patel’s contribution to the Reserve Bank of India. Modi said, “Dr. Urjit Patel is a thorough professional with impeccable integrity.” Perhaps, it’s because of this quality, Dr. Patel chose to resign from his post, as RBI Governor.

Though Urjit Patel has cited personal reasons for his resignation, it will not be unwise to envisage, that Patel quit as his professional integrity could have been compromised in the ongoing tussle between RBI and the central government.

Ever since, Viral Acharya, Deputy Governor of RBI, in a speech at Mumbai, mentioned the need for maintaining the central bank’s autonomy from the government, there were speculations, that Urjit Patel could make such a move. And since it has happened, it becomes utmost important for us to understand the reasons behind such a decision and how important is it for the RBI to function independently.

The central bank is a major institution that has the job of framing the monetary policy of the country. The monetary policy is the process through which the RBI monitors the money supply within the country’s economy, to achieve macroeconomic stability; which focuses on inflation, consumption, growth and liquidity. All such policies are made and monitored by keeping in mind the pace of economic growth.

The government, on the other hand, i.e. the Ministry of Finance, makes the fiscal policy, through which the govt. adjusts its spending levels and tax rates. If in any situation the govt. decides to increase public spending, to boost the economy, the money supply will increase. And due to which, the inflation rate will spike up. At this moment, the central bank through monetary policy will hike interest rates, which will contain the inflation, and keep the economy on track.

Presently, the Govt. of India is trying to influence the policies of RBI. Why? Because of its populist measures.

Due to the large NPA crisis of the commercial banks, RBI had formulated a PCA framework, which dealt with containing the credit, that the banks may provide. And this PCA framework has stringent norms, which hurts credit growth.

Further, the govt. has also demanded the RBI to provide relief to NBFCs which are struggling with crash crunch, after the IL&FS episode; and RBI has refused to change its stance.

Another issue is of using the RBI reserves – that RBI uses for maintaining financial stability – to fund the govt.’s fiscal needs. The govt. has fixed the fiscal deficit target to 3.3% of the GDP, and due to various political and economic reasons, the govt. fears that this target may not be met; unless it finds another source of revenue, besides borrowing. RBI again has refused to oblige.

Viral Acharya, in his speech, had spoken about Argentina’s central bank and had made an analogy with the present situation. Argentinian govt. in 2010 had pressurised its central bank to transfer $6.6 billion of its reserves to the national treasury. Following which, Argentine sovereign bond yield shot up by 250 basis points; which means, that the macroeconomic situation had deteriorated, and particularly, inflation had risen.

That being said, the RBI reserves transfer and allocation of its surplus income is being debated, as of now. And a high-level committee shall be set up soon, to examine the RBI’s Economic Capital Framework (ECF).

Upon the resignation of Urjit Patel, former RBI Governor, Dr. Raghuram Rajan in an interview to ET said, “It is saying that the person cannot stay on given the kinds of policies that are being thrust upon him. It is really the only act that they have in their reservoir when faced with circumstances they cannot deal with. So in that sense this should be seen as a statement of protest and given that Dr Patel is a very honourable civil servant in some sense and a regulator, I think we need to understand what prompted this act.” 

Mint Street and North Block should work together, with respecting each other’s opinions and concerns. There have been conflicts between RBI and Finance Ministry before, but the level of disagreement that is happening now is unprecedented. It was reported recently, that the govt. may use Section 7 of the RBI Act, which has never been used before. This section empowers the govt. to issue directions to the central bank in public interest, otherwise, the central bank works independently. With Urjit Patel’s resignation, it seems that the imposition of this section is inevitable.

It’s interesting to note, that within the Modi govt. Dr. Rajan didn’t serve a full five-year term, Urjit Patel resigned (and didn’t serve his 3-year term), former CEA Arvind Subhramanian resigned, and former NITI Aayog vice chairman Arvind Panagriya also resigned. And all of them resigned due to personal reasons, which is very convenient.

I don’t think there is any better explanation — to what may transpire in the economy if the RBI’s autonomy is impeded — than what Viral Acharya had said, The governments that do not respect their central bank’s independence would sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined the regulatory institution.”

Simply put, Modi govt.’s short-term fiscal needs can prove catastrophic to the Indian economy in the longer run. And no country can be benefitted by having a man heading the central bank, who concedes to all the demands of the govt. Undoubtedly, RBI’s autonomy is under threat.

Subramanian Swamy has said,” The Prime Minister should call him (Urjit Patel) and find out what could be the personal reasons, and dissuade him from leaving.” 

Lastly, Modi Bhakts should surely understand the immensity of this resignation.

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