Clashes between central banks and governments happen the world over. India is no different, yet the recent friction between the Reserve Bank of India (RBI) and Prime Minister Narendra Modi’s government over a controversial rate call offers up a test case of central bank independence in this $2 trillion economy. Last October, the RBI led by Governor Urjit Patel adopted its biggest reform measure in its 80-year history with the establishment of a six-member monetary policy committee (MPC) that makes interest rate calls based mainly on consumer price inflation targets. In the past, that power was vested exclusively with the RBI governor, a government appointee who operates independently but is open to heavy political pressure. The interest-rate decision-making body of monetary experts would create a more arms-length relationship between the central bank and government and avoid the fractious relationship that in the past has caused political dramas in New Delhi. Or that’s the theory at least. However, ahead of a two-day RBI meeting that started on June 6, Finance Minister Arun Jaitley telegraphed the government’s desire for monetary easing, citing the need to improve growth and investment. Any finance minister under these circumstances, said Jaitley, “would like a rate cut.”
Hours after the RBI ignored that call in a 5-1 vote and kept a benchmark rate unchanged at 6.25 percent, Modi’s chief economic adviser, Arvind Subramanian, criticized the RBI for overstating concerns about prices. That barb came after Patel told a media conference that all monetary policy committee members had declined requests from the finance ministry to meet officials before the rate decision.
Modi’s government has reason to worry. The Indian economy, which expanded by 6.1 percent in the January to March quarter, is growing at its slowest pace in two years in part due to a drag on growth from the government’s decision to ban high-denomination notes in November in a bid to curtail corruption. For the whole year to March, the economy grew 7.1 percent, down from 8 percent in the previous year. “The government is trying to pressure the MPC and it risks undermining the credibility of the RBI,” said Shilan Shah, India economist at Capital Economics, Singapore. “It is ill-advised to have the MPC meet the finance ministry officials before the rate decision, but the concept of an independent MPC is still relatively new to India. We may have some teething problems as the committee tries to establish itself.”
The move towards a MPC last year freed the governor from facing the brunt of criticism from the government, which has historically demanded both low borrowing costs and low inflation.
Patel’s predecessor Raghuram Rajan — who had spearheaded the RBI’s overhaul along with the present governor — was accused by members of Modi’s government of keeping borrowing costs too high. The criticism came despite the fact that India was home to some of Asia’s steepest price pressures. “There is some level of divergence of views on interest rates between the government and the RBI,” said Sujan Hajra, chief economist at Anand Rathi Securities Ltd. in Mumbai and a former central banker himself, adding this was common. The RBI slashed its inflation projections, a big departure from April when Patel said growing price pressures needed “close vigilance.” And that may have opened the door to more easing. What’s clear is that India’s central bank will make that decision in its own time.