RBI vs govt: How Nehru's letter can be Modi's weapon to tackle Rahul, Oppn

In the history of Reserve Bank of India, two governors resigned before their terms ended - Sir Osborne Smith (in 1937) and Sir Benegal Rama Rau (1957). At least two other governors - K R Puri and R N Malhotra had their tenures cut short following changes in the government. The RBI’s 'fight' for autonomy is as old as the central bank itself. Over the last two weeks, the rift between the Reserve Bank of India and government has widened. While the RBI and government nominees on the bank's board are set for the November 19 meeting, Congress party President Rahul Gandhi was quick to seize the opportunity to hit out at the Prime Minister-led Narendra Modi government.

Historically there have been differences between the RBI and the nation's governments. But it is Jawaharlal Nehru’s stormy exchanges with Sir Benegal Rama Rau leading to his resignation as RBI governor, that has grabbed the interest of people in the finance ministry. This may provide them with an effective counter to the Rahul Gandhi-led Congress’s attack on the government for undermining the autonomy of the central bank.

The Times of India reported that in 1957 Sir Benegal Rama Rau had to quit from his post as RBI governor because of a fight between the central bank and the government, which was centred around  credit flow to various sectors of the economy — between the RBI’s ‘restrictive policy’ and the government’s ‘liberal’ stance.

Back then PM Jawaharlal Nehru, backed FM T T Krishnamachari and made it clear that RBI was part of “the various activities of the government.

In a letter to Rau, India’s first Prime Minister said, "It (RBI) has to advise government, but it also has to keep in line with government.” He suggested the governor could resign if he thought that it was not possible to continue".

Nehru said it would be “completely absurd” if the central bank followed a different policy because it did not agree with the government’s objectives or its methods. 

“You have laid stress on the autonomy of the RBI. Certainly, it is autonomous, but it is also subject to the central government’s directions. Monetary policies must necessarily depend upon the larger policies which a government pursues. It is in the ambit of those larger policies that the RBI can advise. It cannot challenge the main objectives and policies of the government,” asserted Nehru.

“When you talked to me I pointed out to you that it was for the central government to lay down policies and the RBI could not obviously have policies contrary to those of the central government. You agreed with this. And yet I find in your memorandum a different point of view,” he added.  The same day, Nehru wrote to the governor pulling him up for his “improper approach” which was seen to be “agitational” against the Centre.

Rau put in his papers a few days later.

On October 26, RBI Deputy Governor Viral Acharya in a fiery speech warned that undermining RBI's independence could be "potentially catastrophic".

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.