Eroding of RBI autonomy can prove catastrophic

RBI Deputy Governor Viral Acharya says such efforts could trigger a crisis of confidence in capital markets

In a stinging speech, RBI Deputy Governor Viral Acharya has batted for effective independence of the central bank and warned that undermining its autonomy could be "potentially catastrophic". It could also "trigger a crisis of confidence in capital markets."

His comments come amid government efforts to create a separate regulator for the country's payments system which is currently handled by the RBI as part of its functions related to banking regulations. Government officials have also been calling for the RBI to relax lending restrictions for some banks that have a low capital base.

A government’s decisionmaking is essentially shortterm, like the duration of a T20 cricket match, Acharya pointed out. “There are always upcoming elections of some sort—national, state, and mid-term. As elections approach, delivering on proclaimed manifestos of the past acquires urgency. Where manifestos cannot be delivered upon, populist alternatives need to be arranged with immediacy,” he said.

However, a central bank, Acharya said, plays a test match, “trying to win each session but importantly also survive it to have a chance to win the next session, and so on”. This often means that the central bank builds its credibility by making difficult choices that often lead to sacrificing of short-term gains, for long-term outcomes such as financial stability.

The deputy governor also observed that governments that do not respect central bank’s independence will sooner or later incur the wrath of financial markets.

The deputy governor also observed that governments that do not respect central bank’s independence will sooner or later incur the wrath of financial markets.

He was delivering the A D Shroff Memorial Lecture in Mumbai.

At the same time, governments that invest in central bank independence will enjoy lower costs of borrowing, the love of international investors, and longer life spans.

In all fairness, Acharya acknowledged the key role played by the government in creation of the monetary policy committee with an inflation targeting mandate, two years ago, which has given monetary policy "an independent institutional foundation".

But to secure greater financial and macroeconomic stability, these efforts need to be extended to effective independence for the Reserve Bank in its regulatory and supervisory powers over public sector banks, Acharya adds.

So, legislation should be amended to enable the RBI to extend all the powers currently exercised over private sector banks to PSBs; in particular, regarding Board member dismissals, mergers and license revocation. … It should also remove the option of an appeal to the government when the RBI revokes a license.

In conclusion, he said that market can discipline the government not to erode central bank independence, and it can also make the government pay for its transgressions. Interestingly, the market also forces central banks to remain accountable and independent when it is under government pressure.