Issues associated with RBI functioning

The RBI suggests that its independence is being violated while the government rationalises its intervention in terms of its concern for the economy.

Defining autonomy From the Side of Central bank or from the Government:

The idea of central bank independence began to germinate some two decades ago, this was understood to mean a ‘functional’ independence.

That is, the bank would be unconstrained by the government in its functioning, which includes both the instruments it uses and how it uses them.

However, its autonomy was not to extend to ‘goal’ independence. What the goals of the central bank should be were to be chosen by the government without reference to the bank.

The main issue here was whether the bank should focus on inflation alone or also on the level of employment.

Within a decade of this debate, it had been conceded that the focus would be exclusively on the former, and monetary policy came to be identified with ‘inflation targeting’.

Where Does RBI Stand in Terms of Autonomy?

According to a paper published in the International Journal of Central Banking in 2014, RBI was listed as the least independent among 89 central banks considered under the study.

These rankings are likely to have improved since the adoption of inflation targeting in February 2015 and formation of Monetary policy committee in October 2016.

However, vacancies in RBI’s board and government’s reluctance to fill them up raises questions about the decisions taken and whether proper deliberations on those decisions are being held.

During the previous government, a Financial Sector Legislative Reforms Commission was formed which made various recommendations to cut down RBI’s powers.

In 2013, a financial sector monitoring body, called Financial Stability Development Council was established which was to be chaired by the Finance Minister.

In essence, the RBI Act 1934, does not empower RBI absolute autonomy. However, it does enjoy some independence when it comes to performing its regulatory and monetary functions

What is the RBI aggrieved about?

  • One, the Reserve Bank of India wants more powers over regulating public sector banks (PSBs).
  • Two, it feels that the government should not dictate the quantum of its surplus that can be paid as annual dividend.
  • And three, it is miffed that the Centre has suggested a separate payments regulator.

RBI Governor Urjit Patel told a parliamentary panel in June that it does not have enough powers over PSBs. But the RBI does have nominee directors on bank boards.

It leads physical inspection at banks and financial audits. It has also orchestrated mergers between banks whenever a bank has been on the verge of collapse (for instance, Global Trust Bank merged with Oriental Bank of Commerce).

So, the RBI does have adequate control over PSBs but may not be exercising it fully.

Other issue came up few years back, public spat between RBI and central government over interference of later in policy formulation of RBI has come to limelight. The government had threatened to invoke section 7 of the RBI Act which empowers government to issue directions to RBI to take some action in public interest.

What section 7 says?
1. Clause 1: government can issue instructions to RBI from time to time in public interest.
2. Clause 2: board of directors shall have all powers and do all acts as are done by a bank.
3. Clause 3: the governor shall also have the same powers and functions as board of directors.
From above clauses, it can be discerned that RBI board and Governor have concurrent powers.

There are two issues involved

  1. Issue of relationship between RBI and the government i.e. how far government can go and issue instructions to RBI in public interest so that autonomy of the RBI is not breached.
  2. Issue of relationship between the RBI management headed by the Governor and the board i.e. whether the board can override the decisions of Governor according to majority view.

The government has never issued instructions under section 7 to RBI till now although it has interfered in its functioning from time to time. As per convention RBI board functions as an advisory body and does not pass resolutions binding on the Governor, which should continue as the board has members nominated by the Central government.