Whether the Reserve Bank of India is Independent Enough?

By Sanskriti Shrivastava [1]

INTRODUCTION

Without a doubt, since the very beginning of the Reserve Bank of India (“RBI”), the central bank of our country has worked at par with any of the leading central banks around the world. Unlike any other center-owned body, RBI is fortunate enough to hold independence on a wide range of matters like the function to control and manage the monetary liquidity, prince stability, exchange rate stability, and on a wider note, the financial stability as well. But, in between such quality of work, when the news reports headlines like, “Mr. Patel resigns over government pressure on the bank,” it’s a great misfortune for the country’s economy and a strong signal of loss of autonomy of RBI.

If we look at the post-independence period, the RBI has ample power. However, the picture- perfect autonym of RBI has become an illusion these days, where the Central Government is making continuous efforts to dilute the autonomy of RBI and interfering in its affair of business, specifically by way of Section 7, The RBI Act, 1935.

WHY AUTONOMY OF RBI IS IMPORTANT?

This may be categorized on primarily two reasons:-

  1. The central bank is not a department of executive function of the government: India follows a democracy-based form of government and the Constitution of India or any other related law does not prescribe any specific educational qualification for a person to be eligible to be a member of the Parliament. However, the functions of RBI are complex and thus, require a field expert to be properly handled. As a matter of fact, our Parliament is not competent to understand the technicalities of a complex institution like the Central Bank. Therefore, RBI is not an institution of the government. Rather, it is an institution that derives its authority from specific legislation, i.e., The Reserve Bank of India Act.
  2. The decision making shall be free from considering political windfalls: An independent RBI must take its decisions for macroeconomic stability without any need to consider politically led agendas. The words of Dr. Viral Acharya (Dy. Governor) indicate the very basic rift between RBI and the Government. The former focuses on long-term goals, and the latter is generally motivated by short-term goals. [2]
SECTION 7 OF THE RBI ACT: AN EXTREME STEP

Under Section 7 (1), “the central government may….give such directions to the Bank as it may…consider necessary in the public interest.[3] This provision was not in place since the inception of the Act. The Act was later amended in 1949 to empower the Centre to issue directions to the central bank in the public interest. [4] The clause was drafted after combining the provisions of Section 4(1) of the Bank of England Act, 1946, [5] and Section 5(g) of the Commonwealth Bank of Australia Act, 1945. The intent behind such addition was clear, “The Governor considered it desirable to make it clear in the Act itself that when the Government decided to act against the advice of the Governor, they took the responsibility for the action they wished to force on the Bank, although it was hoped that occasions for the exercise of such powers will be few.[6]

If we look at another perspective as to why such a provision was incorporated, the answer lies in the simple theory that mostly, the Government is blamed for any financial loss to the country. Thus, the one held accountable shall be given some powers too.

Section 7 is the Government’s way to trespass on the Central Bank’s autonomy. Both the critics and supports of Section 7 say that it is an extraordinary provision. However, the power to decide whether to use this provision or not rests with the Government only. Thus, no question of ‘double check’ arises.

THE RIFT BETWEEN THE CENTRAL BANK AND THE GOVERNMENT- INVOKING SECTION 7 OF THE RBI ACT

Section 7 of the RBI was never invoked, even when India faced various financial black clouds like the Liberalization, Privatization, and Globalization policy in 1991 or 2008 global crises. However, its use in the recent past has made the economists and other field experts active to discuss and criticize the action. This action of the Government is majorly related to the resignation of the 24TH Governor of the Reserve Bank of India, Dr. Urjit Patel.

Prime Minister Modi-led Government has come into scrutiny after announcing demonetization on 8th November 2016. Just 2 months before this big step, Dr Urjit Patel took charge as RBI’s Governor after Mr. Raghuram Rajan. He was the head of the central board of RBI that approved demonetization. His silent approval of the demonetization scheme attracted criticism from many renounced economists, including Mr Y. Venugopal Reddy. He took charge as RBI’s Governor from 2003 to 2008. After just a few months, when the country was still struggling to come out of the impact of demonetization, the government strongly pushed for getting a higher dividend from the Central Bank’s surplus earned through operations. Meanwhile, the state-run Punjab National Bank’s scam took the headlines. The then Finance Minister, Mr Arun Jaitley, took no time to blame RBI’s inactiveness and the government’s displeasure by the way the RBI handled the whole matter. He also made some very strong statements.

That was probably the first time when the then RBI Governor, Mr Urjit Patel, strongly supported the role of RBI and mentioned in a public meeting that RBI had enough control over the private sector banks but certainly no control over the public sector banks.

It is pertinent to note here that the Government very clearly stated that it had not invoked Section 7 of the RBI Act but rather initiated ‘Consultation’ with RBI. There are three instances in total which step by step lead to invoking of such ‘consultation’:

  1. RBI’s February 12th Circular was challenged in Allahabad High Court. After the Allahabad High Court’s decision in August, the government issued a letter to the RBI governor seeking his opinion on an exemption for power companies with respect to the 12th February circular.
  2. Further, the government, on 10th October, sought the governor’s views on using RBI’s capital reserves for providing liquidity.
  3. The third letter was regarding the Prompt Corrective Action “PCA” (PCA is used as a tool to prevent weak banks from getting weaker).
  4. Apart from this, the Central Bank and the Central Government do not share the same footing over other matters like classification of Non-Performing Assets and independent regulator for payment system under an amendment proposed under Payment and Settlement System Act, 2007.
CONCLUSION AND WAY FORWARD

The combined reading of legal provisions and what lead to Dr. Urjit Patel’s resignation gives an idea that the legislative framework does not only empower the Government to issue directions, but it also empowers it to supersede the governance system of RBI and other regulators. Section 7 gives unambiguous power to the Government to use its power in the public interest whenever it deems fit. However, such exercise of power stands no tests of law or reasonable criteria in reality. Rather, it holds that a difference of opinion between the Central Bank and the Government can be a reason for invoking such an extreme provision.

Therefore, two goals need to be balanced at this point. First, the central bank must be kept independent from political infringement. A welcome step in this regard is the establishment of the Monitory Policy Committee; and the second, accountability of the economic system.

The above two goals are somewhat in conflict with each other as independence must indeed be established, but at the same time, the role of the Ministry of Finance cannot be ignored. That is to say, somewhere or the other, both these institutions cannot work in complete isolation. Better communication and coordination are what is required.

The government’s power to issue directions and change the constitution of the board is not a daily used provision. It must be used with extreme caution. Also, RBI should be given enough flexibility to function within the ambit of its constraints.

To conclude, the legislature never intended to grant overlapping powers to both institutions. Rather, it demands improved coordination and communication between the relevant government department and RBI.

[1] 9th Semester, School of Law, UPES.

[2] Viral V. Acharya, On the importance of independent Regulatory Institutions: the case study of Central Bank, Lecture delivered as the A.D. Shroff Memorial Lecture, Mumbai on October 26, 2018.

[3] The Reserve Bank of India Act, 1934, §7, No 2 of Acts of Parliament, 1934.

[4] II G. Balachandran, The History of Reserve Bank of India (1998).

[5] The Bank of England Act, §4(1), 1946.

[6] I S.L.N.Simha, The History of Reserve Bank of India (1970).

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