Nov 19 meet: Govt may have its way, but relations with RBI to stay strained

Given the way the govt-RBI relationship has developed lately, nobody can be certain there will be no new twists or turns before the all-important meeting

The ongoing stand-off between the government and the Reserve Bank of India (RBI) does not seem to be heading towards an early resolution. An apparent truce declared through a finance ministry statement on October 31 has turned out to be short-lived.

Instead, all available indications suggest that even though the government may have its say at the forthcoming board meeting of the RBI, the relations between the current top management of the central bank and the leadership team in the finance ministry will continue to remain strained, whose impact on the financial sector will be nothing less than adverse.

Indeed, the differences between the central bank and the Union finance ministry have reached a point of no return. The series of finance ministry letters sent to RBI Governor Urjit Patel in the first half of October was a reaction to the central bank not heeding the many suggestions that the government had made to it. These suggestions included proposals for relaxing the stressed assets recognition norms and transfer of more reserves from the RBI to the central exchequer.

The significance of those letters from the finance ministry lay in the fact that they sought consultation with the RBI Governor on all those issues, citing Section 7 of the RBI Act. Under this provision, the government can give directions to the central bank on all matters in the public interest, but after consultation with the RBI Governor.

In this two-stage exercise, the Modi government has so far used the first step. If the second step is also taken, the government will have forced its decisions on the central bank, but the RBI Governor and his top team will suffer a loss of face. And the institutional credibility of the RBI will also take a hit and the government’s specific action to interfere in policy matters with regard to the financial sector will come out in the open.

Is there a possibility that the government does not have to insist on a direction to be issued to the RBI under Section 7 of the RBI Act? Government sources believe that the only way out of the current stand-off is not necessarily by giving directions to the central bank.

According to them, it is possible that consultations between the government and the RBI may go on for some more time. And there may not even be any need for issuing any directions, as the central bank over a period of time modifies its policies in a way that the differences with the government are narrowed down, if not completely eliminated.

A decision on giving directions under Section 7 has not yet been taken. The government will watch the RBI response to the presentation that its nominees on the central bank board make on November 19. If the RBI approach changes a bit, the government too will make some overtures. If there is no change in the RBI approach, the government will examine its options on the next course of action.

Either way, relations between the government and the RBI will never be the same again. A new chapter on the relationship between the political executive and the central bank would have begun. The contours of that new equation will depend on how well the RBI management and the finance ministry’s top team interact with each other.

The first sign of the tension was the speech delivered by RBI Deputy Governor Viral Acharya on Friday, October 26. It was a hard-hitting speech that warned of adverse consequences if the government did not honour the independence of the central bank. Soon, thereafter, it was revealed in the media that the government had sought the RBI Governor’s consultation under Section 7. On October 30, a meeting of the Financial Stability and Development Council was held in New Delhi under the chairmanship of Finance Minister Arun Jaitley. The RBI Governor, along with the full entourage of all his four deputy governors, was present at the FSDC meeting. The Council discussed various issues, including the government’s desired approach on stressed assets recognition norms.

A day later, there was a statement from the finance ministry which stated the following: “The autonomy for the central bank, within the framework of the RBI Act, is an essential and accepted governance requirement. Governments in India have nurtured and respected this. Both the government and the central bank, in their functioning, have to be guided by public interest and the requirements of the Indian economy. For the purpose, extensive consultations on several issues take place between the government and the RBI from time to time. This is equally true of all other regulators. Government of India has never made public the subject matter of those consultations. Only the final decisions taken are communicated. The government, through these consultations, places its assessment on issues and suggests possible solutions and will continue to do so.”

The statement was widely interpreted to be an indication of the government deciding to lower the temperature and reduce the tension in its relationship with the RBI. However, the promise of a truce was broken as a social media statement from a senior finance ministry official on November 2 made a critical and oblique reference to Viral Acharya’s comments on the economy in the context of a strengthening rupee, falling oil prices, rising stock markets and declining yields of government bonds.

By the same evening, the RBI too put up on its website a speech one of its deputy governors had delivered a few days earlier on October 29. That speech had questioned the logic of treating a defaulter differently just because he might have faced some special external circumstances.

All eyes are now on the November 19 meeting of the RBI board. However, given the way the relationship between the RBI and the government has developed in the last few weeks, nobody can be certain that there would be no new twists or turns before the all-important meeting of the RBI board takes place in less than two weeks.