Next phase for RBI

Central bank should be empowered further

Speaking at a programme marking 90 years of the Reserve Bank of India (RBI) on Monday, Prime Minister Narendra Modi rightly noted that the institution played a pivotal role in advancing the nation’s growth trajectory. Financial stability is a necessary condition for economic growth and development in the long run. As the RBI commemorates this significant milestone, it presents an opportunity for the institution to not only reflect on its past achievements but also to chart a course for the future. This is vital because of the changing nature of macroeconomic and regulatory challenges. The Indian central bank, to be fair, has evolved with time in all its functions over the decades. Despite occasional differences, the government has provided legal and institutional support to the RBI in its journey. This is not to suggest that India has a perfect system, but developments over the years have been in the positive direction.
 

One of the most significant developments in recent years has been the amendment to the RBI Act to make it an inflation-targeting central bank. Despite opposition from various sections, the government agreed to the idea of strengthening the monetary policy framework, which has made monetary policy operations more transparent and helped improve investor confidence. In the context of some recent confusion, on its part, the RBI has done well to reiterate that it will adhere to the legally mandated inflation target. Further, one of the reasons for improving macroeconomic stability is the RBI’s deft management of the external sector. It used opportunities to accumulate large foreign exchange reserves, which has helped reduce currency volatility.
 

While the RBI has done reasonably well in terms of macroeconomic management, particularly in recent years, there is scope for improvement in banking regulation and supervision. It is worth celebrating that non-performing assets (NPAs) in the banking system have come down and the system is in its best position in over a decade, but excesses in the banking system were also built in both pre- and post-financial crisis periods under the RBI’s watch. Although it is correct that the RBI has limited powers in terms of regulating public-sector banks, which must be addressed through necessary legal changes, at least two recent episodes — YES Bank and Infrastructure Leasing & Financial Services Ltd — pointed to the need for improving oversight mechanisms. There are also concerns regarding transparency in dealing with regulated entities. The regulator, for instance, could have been more forthcoming in providing information in the case of Paytm Payments Bank. In fact, dealing with such entities could be a big challenge in the coming years.
 

The RBI has done well to facilitate the adoption of technology, which has made India a world leader in payment solutions, but it will need to be prepared to deal with unintended consequences of using technology by new-age fintech firms in a way that doesn’t stifle innovation. The RBI is also a pioneer in experimenting with the central bank digital currency though it remains to be seen to what extent it is adopted. Looking ahead, although the RBI is not formally an independent central bank, the government should allow it to function autonomously and respect its institutional position. To make its functioning more effective, the government should consider necessary legal changes to empower it in banking regulation. It is also important for the government to run low fiscal deficits to avoid the risk of potential fiscal dominance of monetary policy.