The readers/viewers are spoilt for choice. There is the pre-scheduled India vs Australia series of cricket matches. There is CBI vs CBI. And the latest humdinger is Government vs Reserve Bank of India (RBI).
Every cricket player has his share of bruises, the CBI is broken and, in the case of the RBI, it has been severely bent.
The RBI is the central bank for India. Most people do not know or understand the critical role played by the central bank in the governance of a country. The main objective of a central bank is to secure monetary stability. The objectives of the Reserve Bank of India Act, 1934, are “to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability”.
RBI, many roles
The RBI has several functions. It creates money. It issues currency notes. It sets the interest rates. It exchanges currency. It regulates transactions involving foreign exchange. It keeps the reserves. It manages the debt of the government. It licences and regulates commercial banks and non-banking finance companies. Many of its responsibilities are directly connected to the paramount objective of “securing monetary stability”.
The RBI’s core responsibilities are not different from the responsibilities of central banks of other countries that have an open economy. The premise on which a central bank stands ready and able to discharge its responsibilities is ‘central bank independence’. The Charter of the European Central Bank states, inter alia, “neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body”.
The principle of central bank independence is now virtually an immutable law. Therefore, although the RBI was constituted under an Act of Parliament, the RBI is not — and cannot be treated like — a Board-managed company. Everywhere in the world, central bank = Governor (or Chairman). It is this principle of central bank independence that has been challenged by the NDA government. Everything that is done under the Act, therefore, has to be consistent with the underlying premise of the Act; otherwise it would be ultra vires.
On November 19, 2018, the principle was severely tested — and breached. At a meeting of the Board of Directors of the RBI, four decisions were taken:
– The Board decided to constitute an expert committee to examine the Economic Capital Framework (ECF), the membership and terms of reference of which will be jointly determined by the Government and the RBI;
– The Board advised that the RBI should consider a scheme of restructuring of stressed standard assets of MSME borrowers with exposure up to Rs 25 crore;
– The Board decided to retain capital adequacy ratio (CRAR) at 9% and agreed to extend the transition period by one year; and
– The Board decided that the issue regarding banks under the Prompt Corrective Action (PCA) Framework will be examined by the Board of Financial Supervision of the RBI.
In my view, it was a disastrous meeting that cut a dangerous new path. On three of four matters, the Board took decisions. Once the government had drawn blood, it stepped back from actually invoking Section 7 (to issue Directions) or Section 58 (to make Regulations). Nevertheless, it is clear that the camel has its nose in the tent; it is only a matter of time before it has its trunk and feet inside.
I have no reservation in believing that most of the independent directors on the Board are distinguished professionals or successful businesspersons in their respective field or fields. However, none of them was, or is, a central banker and none of them has domain knowledge of central bank functions. Besides, from many accounts of the meeting, it can be inferred that the independent directors were not independent of the government that appointed them; they seem to have enthusiastically supported the government’s position. The same Board had failed the country when it meekly endorsed demonetisation on November 8, 2016. Now, after two years and 10 days, the Board has once again failed the country by breaching central bank independence.
Accountable, not Subordinate
It is par for the course for the finance minister and the Governor to agree (more often) or disagree (occasionally) on the repo rate or CRR. I am in favour of some tension between the government and the Governor and, on occasion, in favour of the government expressing its disappointment. I am in favour of Parliament calling the Governor more frequently to explain his actions before a committee. I am in favour of academics and the media fearlessly criticising the Governor’s decisions. However, I strongly disapprove of government-appointed directors deciding issues that fall within the jurisdiction of the central bank/Governor. Whether they do so ‘independently’ or on the ‘instructions’ of the government is immaterial; in either case it is an encroachment and will destroy the fundamental principle of central bank independence.
At the next meeting of the Board on December 14, 2018, there will certainly be a determined push by the government to make the Board decide on more issues. If Dr Urjit Patel does not stand his ground, and yields more space, another institution — a venerable one — would have fallen. For the present, I shall utter a prayer and keep my fingers crossed.