RBI Autonomy: Is the Government out to Impound its Autonomous Status?

Recent developments have subsided the prospects of rift between RBI and the Government. The earlier event indicating the beginning of conflict between the Apex Monetary Authority The Reserve Bank of India (RBI) and the Financial Authority – Ministry of Finance-Govt of India had sparked speculations that the Governor of RBI, Mr Urjit Patel could step down as the RBI feels that Government which should not interfere in its Monetary affairs in keeping and improving the monetary position of the country to a healthy and globally competitive standard, was trying to make unnecessary intervention that may hamper its autonomous working. 

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With the marathon meeting of RBI Board held on Nov 19, 2018, the Government and the RBI both decided not to follow the path of confrontation and arrive at certain decision for good of the economy and keep the confronting issues in abeyance.  

This has become a hot economic topic for Group Discussion (GD) Round as well as for Writing Ability Test (WAT) in various competitive exams. Experts have gathered the key facts on the topic and suggest to use the content carefully as per the GD or WAT requirements. 

RBI Board Meeting Dated Nov 19, 2018

Reserve Bank of India Board held a 9 hours long meeting on November 19, 2018 to discuss various issues that created rift between the RBI and the Government of India. The issues included: Capital Requirement of RBI; Financing Norms for Small and Medium enterprises (SMEs); and to further define and modify the Rules for Weak Banks. The meeting ended calling a truce between the Government and the Reserve Bank of India with following decisions:

1. The key issues of creating rift between the Government and RBI namely Transfer of Surplus Reserves and the Relaxed Norms for Weak Banks were referred to committees.
2. Concessions were made on Capital Adequacy Ratio (CAR) of Banks. But the RBI board did not agree to bring down the capital adequacy ratio in line with bare minimum levels prescribed by Basel III norms. Simultaneously, the board has extended for one more year the process for implementation of the capital conservation buffers. According to the statement issued by RBI after the meeting, ““The Board, while deciding to retain the CRAR (capital to risk weighted asset ratio) at 9%, agreed to extend the transition period for implementing the last tranche of 0.625% under the Capital Conservation Buffer (CCB), by one year, i.e., up to March 31, 2020.”
3. Relaxing and Easing the prompt corrective action (PCA) framework for weak banks has been referred to a committee while the government is pushing for a review to allow a few Public Sector Banks out of this framework. Under RBI’s PCA framework are 11 of the 21 PSBs. In view of the Government, these PSBs are restricting credit flow to economy, including MSMEs. The board in its meeting has advised RBI to ask the banks to recast loans upto Rs.25 crore disbursed to Micro, small and Medium Enterprises (MSMEs)
4. The issue of fixing a capital framework has been referred to the committee. The fixing of a capital framework would free up RBI’s surplus reserves for transfer to the central government. Since the government requires to meet its fiscal target of 3.3% of GDP due to low tax collections, the government is contemplating that the RBI surplus transfer will help it in bridging the gap. However RBI is of the view that the reserves are very important to protect the economy during any crisis.
5. No Agreement was reached in regard to the liquidity shortage faced by NBFCs. However, RBI has announced to inject Rs.8000 crore liquidity through open market operations in November 22, 2018. In order to ease the liquidity crunch at Non-Banking Financial Companies, the largest PSB-State Bank of India has announced to buy loans worth Rs.45,000 crores from the NBFCs. Besides, the refinance window of National Housing Bank (NHB) has also been increased to Rs.30,000 crores.

As such, now the prospects of invoking Section 7 of RBI Act 1934 by the Government, are very dim and the Central Government and RBI relationship may not go low.

Back-Ground

• Reserve Bank of India, the central bank of the country is an autonomous organization responsible for all the key monetary roles like Monetary controls, money supply regulation, foreign exchange, apex lender to Government, a bankers’ bank among others. RBI was created and is governed with the RBI Act and as such is a statutory autonomous entity. 
• However, in October 2018, the Ministry of Finance, Government of India moved to invoke Section 7 of the RBI Act. The Section 7 gives powers to the government to seek consultations with RBI. If necessary, the Government may issue certain binding orders on RBI in public interest. Despite keeping its existence in RBI Act, this section has never posed any threat to RBI Auotonomy earlier as it has never been invoked even during the times of Wars fought with Pakistan and China; during the adverse balance of payment crisis or even during the period of demonetization that happened on November 8, 2016.
• The three letters under Section 7, that were sent by the Government of India to Reserve Bank of India for consultation included the issues like Capital Adequacy Norms for Banks governed by RBI, Liquidity Crisis, Credit to Micro, Small and Medium Enterprises (MSME), Corrective measures for weak banks among others.
• Promptly responding to these letters of GoI, the Reserve Bank of India remained firm on its stance and did not commit for the changes as desired by the Government in its policy and action plan.
• The series of events after this communication let the problem aggravate and it is being speculated that the autonomy of the apex Monetary Authority of India, RBI is at stake and as a result the Head of RBI – Mr Urjit Patel may step down. During all this controversy, Mr Arun Jaitley, the Finance Minister of India has asserted that the Government respects the RBI Autonomy and also feels it is necessary to maintain. Accordingly, the finance ministry has not yet given direction to the RBI to follow the instructions issued by it while invoking the Section 7 of RBI Act.

What is Section 7 of RBI Act 1934?
The Section 7 of RBI Act has three parts. The most relevant first part which has sparked the tensions between RBI and the Government, states: “The central government may from time to time give such directions to the Bank (RBI) as it may, after consultation with the governor of the bank, consider necessary in the public interest.”

The Part two of the section 7 of RBI Act says, “Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a central board of directors, which may exercise all powers and do all acts and things which may be exercised or done by the Bank.”

Why the Need Felt by Government to Invoke Section 7?
So far the discussions and consultations between the Ministry of Finance and the Reserve Bank of India have taken place without resorting to use of Section 7. The invocation of section 7 of RBI Act is considered very important for consultations as it gives the Government the scope to issue directions as it finds fit to the Reserve Bank of India.

It is also contemplated that the government might have drawn inspiration for using the Section 7 from a recent judgment of the Hon’ble High Court of Allahabad delivered in a case filed by power producers against the RBI’s February circular that mandates early detection and time-bound resolution of stressed assets. The High Court had asked the finance ministry to have consultations with the RBI within 15 days, under Section 7 of the RBI Act 1934 to resolve the issue.

HC Asks Government Not to Issue Directives to RBI
In its order on August 28, the HC had asked the Govt to refrain from issuing any directives to RBI. The order said “The central government, however, is not expected to issue any directions, as contemplated under Section 7(1), indiscriminately or randomly. Such directions are possible when there exists sufficient material in support.” 

RBI Conveyed it Position: Differs from Govt Point of View
In its reply to the Ministry of Finance on the three letters, RBI has conveyed its position on the need to retain the “stringent” prompt corrective action (PCA) framework for stressed banks and has stated that there is no liquidity crunch. The MoF, Government of India and RBI have also differed on the issue of capital adequacy norms for banks.

The RBI has given the instructions that the banks should maintain capital-to-risky asset ratio (CRAR), including capital-conservation buffer, at 11.5% — 1 percentage point higher than Basel norms. Besides, the common equity tier (CET)-1 of banks is required to be at least 5.5% of its risk-weighted assets — again 1 percentage point higher than the global norms.

However, the ministry of Finance wants the stipulation aligned with the international practices also, so that banks can lend more and add to economic growth.

Government Not Impounding RBI Autonomy: Key Points

• The Finance Minister Arun Jaitley has blamed the RBI for not doing enough to control “indiscriminate lending” by the public sector banks during 2008-14 period
• This has precipitated the balance-sheet problem of both the lenders and borrowers under severe, seemingly inescapable stress
• On October 31, 2018 Government said that it respects the autonomy of the central bank but it will “have to be guided by public interest and the requirements of the Indian economy”
• As the Government wants to manage the fiscal situation, prop up investments & consumption in the economy, ensure that the small businesses and trade as well as people are not upset with the government in the run-up to the elections, the government can insist on high transfer from RBI’s ‘surplus’ pool
• Former chief economic adviser Arvind Subramanian had also suggested that the central bank’s ‘excess capital’ could be redeployed to bolster the capital base of state-owned banks
• The finance ministry has also sought changes to the “stringent” prompt corrective action (PCA) regime for stressed banks
• The Finance Ministry has suggested that the framework of corrective action be aligned with best global practices to allow banks have room for growth

RBI Dy Governor Acharya Criticises Government Move
RBI Dy Governor has criticized the move of the Government. Finding that government is trying to sneak into the central bank’s autonomous regulatory space, the Deputy Governor of RBI, Viral Acharya has criticized the Government’s move and has warned that it could spur “potentially catastrophic” consequences.

Delivering the AD Shroff memorial lecture, Acharya said governments that did not respect their central banks' independence would sooner or later incur the wrath of financial markets. The much discussed famous speech, ‘On the Importance of Independent Regulatory Institution – The Case of the Central Bank’, by Acharya reaches a host of issues.

The content of the speech which confronts the Government on all the issues against its move to undermine the autonomy of RBI has aroused unprecedented media response. 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.

Acharya has pointed out that the breaking down of the RBI autonomy is associated with 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.

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

Acharya has pointed out that RBI faces constraints in the regulatory framework as well as in implementation of the regulatory decisions in the regulation of banks, particularly public sector banks. These limitations are related to asset divestiture, replacement of management and boards, licence revocation and resolution actions such as merger or sales.

In another speech, on October 12, titled ‘Prompt Corrective Action: An Essential Element of Financial Stability Framework’ Acharya warned the Government against on diluting the risk threshold set out by the RBI in various indicators.

While the RBI has insisted on Prompt Corrective Action (PCA) as a regulatory framework to ensure a healthy banking system for long-term growth, macroeconomic stability and financial stability, the Government, if it does not respect central bank independence will sooner or later incur wrath of financial markets, ignite economic fire and come to rue the day they undermine the regulatory institutions.

Acharya said that the government's horizon of decision-making was rendered short, like the duration of a T20 match, by several considerations.

RBI Autonomy at Stake: Experts’ Views
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, former RBI Governor said, “A central bank is not expected to be subordinate to the government.” Adding further he said, “My single objective is to protect the Indian economy from the Government of India.” He also said, “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.”
• Raghuram Rajan has also criticized the undue interference of the Government in RBI working. He said “India needs a strong and independent RBI to ensure macroeconomic stability”.
• Former RBI Governor D Subbarao sarcastically commenting on Government’s interference in RBI working, said, “But thank God, the Reserve Bank exists.”
• On the move of Government to belittle the autonomy of RBI, Dr Raguram 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.”
• Experts feel that the RBI needs to maintain a strong balance sheet to perform its functions effectively. The perception that the RBI capital is in excess of what generally other central banks have is because of the amounts held in the currency and gold revaluation account (which stood at `5.29 lakh crore on June 30, 2017). The gains arising out of revaluation of foreign currency assets are notional and cannot be treated as free reserves that could be transferred to the government.
• In view of all the experts, the 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.
• While the RBI frames the monetary policies in the long-term interest of the nation, the government tends to believe that RBI will sing to its tunes as it has made the apex appointments in the bank
• The Government’s priorities due to upcoming elections may change to deliver on proclaimed manifestos of the past. The Government may need deliver on populist alternatives as its manifesto could not delivered upon. But that cannot be the priority of RBI. 
• RBI should not be directly subjected to political time-pressures and the induced neglect of the future. The government should stop using the RBI against the interests of the Nation and let RBI do its jobs as per statutes, mandates, practises 

RBI and Government Interface: Instances of Support

• RBI has put in place a rule-based ‘staggered surplus distribution policy’ (SSDP) in FY18. The central bank transferred `50,000 crore surplus in two installments, `10,000 crore in March 2018, to help the Centre tide over a tight fiscal crunch and the remaining amount in August to reduce the impact of cyclicality in the RBI’s economic capital levels on the surplus transferable to the government.
• Government should understand that RBI has to take the stressed banks out of the dilemma by taking various measures. Acharya recently said that without the PCA imposition, some banks would have witnessed even higher losses and required even higher taxpayer money for re-capitalisation.
• 11 of the 21 public-sector banks are on the RBI’s watchlist for battered financial position. Under the PCA guidelines, stressed banks operate under some tough conditions. The lenders are stopped from expanding their branch networks and need to maintain higher provisions. They may be stopped from lending until they correct their finances.
• RBI has also recently made public its dissent note on certain recommendations of a government panel under the economic affairs secretary that opposed the idea of setting up an independent regulator outside the central bank to deal with issues relating to payments.
• As regards monetary policy, the introduction of inflation targeting and constitution of the Monetary Policy Committee (MPC) are examples of effective and efficient government and central bank interface.
• 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. 

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