The Reserve Bank of India is independent but within the limits set by the government, says former Governor Y.V. Reddy, who also feels there is no such thing as “blanket independence” for a central bank. His remarks come amidst a raging debate over the independence of RBI and are elaborated in his just-released autobiography, ‘Advice and Dissent’ (Harper Collins India). He discusses at length the “critical” relationship between the government and the central bank, which he describes as “walking on a razor’s edge”. In a humorous vein, Reddy, who was Governor between 2003 and 2008, recalls what he had said in reply to a journalist’s question on how independent RBI was, when he had just taken over.
“I am very independent. The RBI has full autonomy, I have taken the permission of my finance minister to tell you that,” he had said. Then he himself poses the question, “In all seriousness, is the RBI independent?” and answers: “The RBI is independent but within the limits set by the government.” Reddy says in the book that in all countries and in all times, it is the relationship between the government and the central bank that is critical.
“Sometimes, these interactions can be like walking on a razor’s edge. The relative emphasis between autonomy for the RBI and accountability to the government is difficult to define and complex in practice,” he says. The bureaucrat-turned central banker writes that there are three operating spheres of activity in the RBI-government relationship — operational issues, policy matters and structural reforms. He says when it came to operational matters he insisted on the freedom to decide and on policy matters he was particular about consultations to avoid discord and ensure harmony in policies. On structural issues, he believed in very close coordination with the government.
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“While interacting with the government, I had to sometimes take a firm stance on important issues. If there were persisting differences of views, I was prepared to annoy, or even irritate and frustrate the sovereign, if necessary. But I was not inclined to defy.” Reddy says in the final analysis, the sovereign is a sovereign. “In extraordinary situations, it is the sovereign which has the primacy. Also, the law provides for the government to give written directives in public interest. “In the case of the RBI, however, prior consultation with the Governor is mandatory. On critical issues, where there is difference of opinion, often the choice is for the Governor to concede to the sovereign with or without a written directive. By tradition, both the government and the Governor avoid recourse to any written direction,” says Reddy.
Towards the end of his tenure, he was asked whether he believed in a single objective in an apparent reference to price stability. ” ‘Yes’, I replied. My single objective is to protect the Indian economy from the government of India.” In some sense, Reddy says, that is the reason for the existence of RBI. The government created the RBI to moderate its temptations to take a short term view on matters relating to money and finance. “For a central bank, there is no such thing as blanket independence. The extent of autonomy exercised by the RBI depends on the functions being performed by the bank and the nature of the relationship between the RBI and the government, particularly the relationship between the finance minister and the Governor,” he says.
Reddy says the independence of RBI also faces certain structural constraints. The government is a dominant owner of the banking system in India and the banking system dominates the financial sector.”Moral suasion addressed by a central bank to the banks is not uncommon globally. But the RBI cannot exercise such an option unless the government, which is the owner of public sector banks, tolerates it,” he says. He also notes that the relationship between the Governor and the finance minister is necessarily “an unequal and complex one”.
In his book, Reddy gives an interesting nugget of information when in May 2008, the oil companies were in a crisis relating to payment of money to import oil. The RBI brought out bonds for the government which issued them in lieu of subsidies. This he did to avoid panic gripping the system. The RBI brought the bonds with rupees and simultaneously exchanged them with US dollars. “(The then finance minister) P. Chidambaram expressed displeasure since I did not consult the government. But he backed the decision. The move invited criticism from many circles, as people assume that we in the RBI did it at the behest of government and that it undermined the independence of monetary policy, exchange rate management and balance sheet of RBI. “It was ironic that analysts criticised us for obliging the government while the government was unhappy for not being consulted in advance,” he says.