Forbes India 15th Anniversary Special

Economy: RBI vs Govt

Why the central bank might have to toe the line

Salil Panchal
Published: Nov 4, 2018 03:04:23 PM IST

Economy: RBI vs GovtMinister of Finance Arun Jaitely (left) and RBI Governor Urjit Patel. Relationships between the government and RBI governors have traditionally been slightly frosty
Image: Mohd Zakir/Hindustan Times Via Getty Images

An ugly public spat between a country’s central bank and its ruling government is never good news, although it makes for great headlines, coming just a few months ahead of the general elections in April 2019. But this is not what India or investors need, with the markets facing a heady mix of rising oil prices, a depreciating rupee, outflow of overseas funds, concerns over slowing economic growth, and a credit crunch for non-banking financial companies (NBFCs).

On October 26, Reserve Bank of India (RBI) Deputy Governor Viral Acharya, at a public event, warned that governments “which do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution.”

The government then retaliated, by blaming the RBI for some of the problems India faces, particularly for failing to deal with bad loans that commercial banks have been struggling to deal with since 2013-14 and for failing to detect the Nirav Modi fraud at the Punjab National Bank (PNB). It has also raised fears that RBI Governor Urjit Patel—who appeared to have fallen out of favour with the government—might resign soon. An RBI board meeting scheduled for November 19 is likely to reveal more.

Previous governments and central bank governors have always had slightly frosty relationships, whether it be between former RBI Governor YV Reddy and then Minister of Finance P Chidambaram over issues relating to opening of the banking system to foreign ownership, or RBI Governor D Subbarao who had faced criticism for often keeping interest rates firm, which could curb economic growth.

Experts believe that some of the current fracas could have escalated due to weakening investor sentiment and economic growth. “The government wants to bring back growth in a major way, political survival might have caused this,” says a senior official at proxy advisory firm, InGovern Research.

A former head of a foreign bank agrees that the government’s posturing could be political, and that the RBI also might not have been seen as doing enough to revive growth. “The RBI showed support to deal with the NBFC liquidity issue, but did not release money to ease the situation, particularly towards wholesale and real estate financing,” she says, declining to be named.

A contentious issue is how the government will use Section 7 of the RBI Act in the future. It empowers the government to appoint directions to the RBI on matters of public interest—something that the RBI clearly does not look forward to. “If the government invokes this section regularly, the role of the RBI will be compromised,” the former banker says. “Though autonomous, the truth is that every regulator has to be accountable to someone.”

The government has used this section thrice in the form of a letter of consultation, but is yet to invoke it to issue specific directions or instructions to the RBI. The government, in a statement on October 31, said that “both the government and the central bank will have to be guided by public interest and the requirements of the Indian economy.”

Patel will continue to walk the tightrope for some more time. The RBI’s move to shorten the tenures of Axis Bank CEO Shikha Sharma and Yes Bank’s Rana Kapoor has also not gone down well with the government and banks. “They could have been delicate in dealing with this matter by tapping [the bosses] informally, instead of informing the bank,” says an official with a private bank, declining to be named.

A fractured relationship with the government and other banks will only leave the RBI, and Patel, isolated in the coming weeks. But Ridham Desai, Morgan Stanley India’s head of India equity research, believes the grievances will get fixed. “I would dare say that the RBI is more independent than it has ever been in the past. Can it be more independent? The debate will be resolved.”