The government has sought consultations with RBI under ‘section 7’ of the RBI Act 1934. This provision empowers the government to issue directions to the RBI. With the recent speech of Viral Acharya warning against the undermining of RBI’s authority, the whole matter has now spilled in the public domain. The online financial publication Moneylife has also speculated that ‘Urjit Patel’ may resign in the backdrop of the tussle between government and RBI.
In the economic history of India, section 7 of RBI act has never been used. It was not used when the country was nearing default during the balance of payments crisis of 1991 nor during the financial crisis of 2008. Hence, the initiation of section 7 is seen as an extreme step by the government against RBI. In the light of these happenings, it becomes important to see as to what provisions ‘section 7’ of RBI act contains.
‘Section 7’ of RBI act, 1934 works in two steps:
1) Consultation with RBI
2) Issuing directions to RBI.
Once ‘Section 7’ is invoked, a Central board of directors is constituted. This board consists of Governor, Deputy Governor, Four directors, and a government official. All of them are appointed by the Central government. The powers of RBI are then transferred to this ‘Board of directors’ constituted by the government. This way, the provision enables the government to exercise greater control over the RBI functioning.
It also becomes important to see as to why differences between RBI and government have accentuated in recent times. The government has been trying to push for dilution of the prompt corrective action framework (PCA). Eleven such public sector banks are under the PCA framework. Relaxation of PCA will give PSBs more freedom to provide liquidity in the banking system. They will also be able to buy debt papers of NBFCs’ which are currently facing a liquidity crunch. Although RBI has rejected this proposal emphasizing the need of such a framework to regularize and revitalize the weakened banks.
The government has also demanded more capital from RBI reserves. The government wants ‘Basel III ‘capital norms for banks which are lower than those prescribed by the central bank. This proposal has also faced strong opposition from current and former RBI officials. RBI Deputy Governor has stressed on the importance of maintaining adequate reserves to maintain the confidence in the central bank.
Also, it is a well-known fact that the government has never been pleased with RBI’s cautious stance against the inflationary pressures. As government has always wanted RBI to infuse liquidity into the markets leading to developmental activities. Whereas, RBI has time and again underlined the need for inflation controlling measures to maintain the stability of the economy. All these matters were highlighted in three letters sent the by government to RBI last month. Though RBI responded to these letters, it rejected all the government proposals and maintained its stance of not yielding to government pressure.
This conflict between country’s Apex bank and Central Government is certainly disturbing. Fiscal Authority (Government) and Monitory Authority (RBI) should work in co-ordination and co-operation for the economy to thrive. And most government should refrain from invading into decision making space of RBI when it comes to monetary matters.
Undermining RBI’s autonomy by the invocation of ‘Section 7’ can have grave consequences. It can make foreign investors lose faith in the country’s economy. It can also set a trend of suppressing RBI. As The text of the ‘section 7’ is slightly vague and open to interpretations. As it reads, “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.” The term ‘Public interest’ is not clearly defined here and is open to interpretations. Upcoming governments could also make usage of this provision a norm siting ‘Public Interest’.
Almost always the governments are motivated by electoral gains. And hence, fiscal decisions by the government are many a times not very pragmatic but rather populist.
RBI was made to be an independent authority to save the country’s economic stability from sentimental, populist measures of governments. Hence government should keep its hands off RBI and let experts at RBI do what they do!
As allowing the government to control the country’s Apex Monitory Authority through invoking ‘Section 7’ of RBI act will open a Pandora’s Box that will set catastrophic consequences in motion.