Battle That Needs Introspection
FM-RBI spat represents the need for an honest attempt to identify lapses in financial governance and remedies that do not encroach on each other’s responsibilities and rights
The ongoing differences between the Reserve Bank of India (RBI) and the government over the central bank’s autonomy, specifically in terms of decision-making, are a classic example of how the weakening of the domestic institutions can potentially destabilize the economy.
As for the role of institutions in an economy, there is a wealth of literature on the two schools of thought on institutions and their role in an economy. In terms of ‘old institutional economics’ – subscribed to by economists like Commons, Veblen, Hodgeson and Galbraith among others – individuals are considered to be susceptible to (or molded by) the influence of the prevailing institutions and cultural situations. Thus institutions are considered to be important agencies that influence the behavior of individual agents in markets with their “informational cognitive” functions.
As interpreted above, business concerns and strategies are influenced by institutions. They usually influence and exercise a major role on those decisions in market economies. Depending on the business environment and the direction of change in the prevailing institutions, the impact can be facilitating or destabilizing.
With markets uncertain, and uncertainty as such subject to grading, institutions may reduce or enhance uncertainty and thereby change the level of confidence. Norms and prescriptions offered by institutions can thus be responsible for the varying responses in the market.
The role of institutions deserves a mention in relation to the current state of the Indian economy and the rift as has come up between the central bank and the official treasury, represented by the Ministry of Finance. These are in the context of the current situation where the financial sector has been facing multiple problems which include the shortage of liquidity and the related drop in credit flows.
The issue, however, is just the tip of an iceberg which has been building up over some time, with the piling up of nonperforming assets (NPAs) in both state-run and private banks, the near-collapse of the non-bank financial corporate (NBFCs) including the bankruptcy of the IL&FS and the credit squeeze faced by the MSME concerns, to name a few.
The drop in credit availability is currently viewed with concern by the finance ministry, which seeks a remedy with demands on the RBI to make available additional cash. Demands as above have met with displeasure from the RBI which considers such moves as an infringement on its autonomy.
Problems in India’s financial sector can be