Emerging challenges for RBI: The central bank will need to keep adapting

The Reserve Bank of India (RBI) this week completed 90 years. Governor Sanjay Malhotra in a column in The Times of India on Tuesday highlighted some of the functions of the RBI and how it was preparing for the future. This significant milestone in the life of the central bank offers an opportunity to discuss the kind of challenges it may face in the coming years. The shape of the Indian economy has changed significantly over the past few decades with increasing engagement with the global economy. As a result, the demands on the central bank have also changed. The RBI, to be fair, has adapted well to serve the needs of a rapidly growing economy. Aside from occasional differences, which is normal in a modern economy, the government has also done its bit to support the central bank. The government, for instance, got the RBI Act amended to enable the adoption of flexible inflation targeting in 2016, which has served India well.

 

In terms of challenges, the unpredictability of the US trade policy, or policy in general, which has increased global uncertainties, will keep the risk on the external front elevated. Even though India’s current-account deficit is expected to remain low, unpredictability in the global environment can affect capital flow as has been the case over the past several months. Although the RBI has enough foreign exchange reserves to address excess volatility, it’s not clear how long the imponderables will last and how the global economic order will shape up. The RBI needs to be alert. It requires differentiating between short-term volatility and long-term fundamental shifts. It’s been a recurring criticism that the RBI’s active intervention keeps the rupee overvalued, affecting the tradable sectors.

 

The other challenge for the central bank will be maintaining price stability. The retail inflation rate is expected to come down this financial year, which will open up space for further monetary easing. However, from the medium-term perspective, it is worth noting that higher food prices largely drove the inflation rate in recent years. Given the increasing impact of climate change on weather patterns, agriculture output and prices may witness greater volatility. The monetary policy committee may have to respond to food price shocks more frequently in the coming years, which could affect growth prospects. Maintaining the balance with the given legal mandate could become more challenging.  

 

The RBI also needs to adapt in terms of regulations and supervision. As recent developments in a private sector bank showed, the regulator needs to be more transparent. If it has to approve appointments, it must give reasons for disagreeing with a board’s recommendation or approving a truncated tenure. It is also worth noting that the RBI’s approval of appointments has not eliminated the possibility of a mishap. It should perhaps focus more on improving the supervision of banks and other regulated entities. In any case, it has limited powers in regulating public-sector banks, though this is not of its own making. In the coming years, the RBI will also have to deal with challenges emanating from increasing digitisation. While digitisation has increased financial inclusion and improved quality of service, risks have also multiplied. Easy availability of credit can increase household indebtedness, particularly in underprivileged categories. Greater digitisation also means round-the-clock banking and any weakness in the system could pose financial-stability risks. The RBI must be prepared for these evolving challenges.

 

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