Why India’s Modi wants to increase control over the central bank
MUMBAI/NEW DELHI, (Reuters) - An incendiary speech by a top Reserve Bank of India (RBI) official last Friday blew the lid off an increasingly toxic dispute between the central bank and the government of Prime Minister Narendra Modi over monetary policy and who controls the institution’s reserves.
While historically there have been differences between the RBI and the nation’s governments, the extent of the rift and its public nature are unprecedented.
By Wednesday morning, there were Indian media reports saying that RBI Governor Urjit Patel was about to resign. The RBI declined comment.
This followed three letters to the RBI from the finance ministry threatening to invoke Section 7 of the RBI Act that would allow the government to dictate policy to the central bank, according to a senior source with direct knowledge of developments.
But faced with declines in India’s rupee currency and government bond prices as investors got unnerved, the government issued a statement supporting the RBI’s autonomy while indicating it would still be pressing very hard to have its own way.
In Friday’s speech, RBI Deputy Governor Viral Acharya said that undermining central bank independence could be “potentially catastrophic”, and he even cited meddling by the Argentine government in the affairs of its central bank in 2010 – prompting big drops in that nation’s financial markets - as a sign of how bad things can get.
The remarks were widely seen as a sign that the RBI was pushing back hard against government pressure to relax its policies and reduce its powers ahead of a general election due by May.
Finance ministry and RBI spokespersons declined comment.
The RBI is not statutorily independent, as the governor is appointed by the government, but it has enjoyed broad autonomy in regulating the banking sector. It is mandated to control inflation within a 2 to 6 percent range while keeping in mind India’s economic growth objective.
HERE ARE SIX CRITICAL AREAS OF CONFLICT: CASH GRAB - The government has made repeated calls for the RBI to hand over more money from the RBI’s reserves to help fund its fiscal deficit. The RBI currently hands over its profits earned from various activities in the form of a dividend. But the government also wants to tap a share of the RBI’s 3.6 trillion rupees ($48.73 billion) of capital reserves. The RBI has consistently pushed back against the demand. OUT OF THE SHADOWS -The government wants the RBI to provide more liquidity to the shadow banking sector, which has been hurt by the defaults of major financing company, Infrastructure Leasing & Financial Services (IL&FS). Those defaults triggered sell-off in bonds and stocks of non-banking financial companies. The government has been asking the RBI for a dedicated liquidity window for these lenders similar to one allowed during the 2008-2009 global financial crisis.