The uneasy relationship between the finance ministry and the Reserve Bank of India was one of the worst kept secrets in the financial sector, but observers say even the fig leaf was taken away today.
On Saturday, at a seminar organised by the industry lobby group, Assocham, Finance Minister Pranab Mukherjee said he "hoped RBI would adjust its monetary policy stance to boost growth". He also said RBI should not worry about the rise in inflation in May, as it was due to supply-side issues, for which monetary policy has a limited role to play.
Two days later, RBI governor D Subbarao put the ball straight in the finance ministry's court by saying supply-side issues needed to be addressed to revive investment and the role of an interest rate cut was minimal in reviving growth. According to RBI, in April, rates were front-loaded (the cut was more than expected) on the expectation that the Centre would act to get the fiscal situation in order. Clearly, today's message from Mint Road indicates the expectation is yet to be fulfilled.
Tension between North Block and RBI has been brewing for some time. Central bank officials point to the increasing intervention of the finance ministry in RBI activities in recent times. The government was also seen to be trying to micro-manage banks and issuing guidelines to them, which RBI thought came strictly under its purview. For example, the ministry recently issued norms for consortium lending by public sector banks
RBI has now decided to pursue the matter by writing to the government. A letter has been send to the government, detailing how the finance ministry had encroached upon the regulator's territory.
RBI sources said the relationship first turned sour after the scrapping of the high level committee of regulators, which was headed by the RBI governor. A new structure was created, a Financial Regulatory and Development Council (FSDC), headed by the finance minister.
The governor was relegated as the head of a sub-committee. The FSDC was formed despite Subbarao's questioning the objective of such a forum.
Later, the governor's public comment against setting up an independent debt management office also did not go down well with the ministry.
The government recently amended the law to send two representatives from the government to the RBI board, instead of one. The move was also seen as the ministry's effort to tightening its grip on Mint Road.
Ironically, Subbarao, who joined Mint Road from the ministry directly when
P Chidambaram was the finance minister, was initially accused of being the finance ministry's hand-maiden. He dispelled the impression later, but RBI sources said the comfort he enjoyed with Chidambaram was missing in his relationship with Mukherjee.