The brief controversy over the clauses in the Finance Bill which, if passed, would have taken away the Reserve Bank of India's (RBI's) regulatory powers in relation to the money and government securities markets appears to have passed. The resolution appears to be that the status quo will be maintained for now and the clauses will be substantially modified or withdrawn from the final version of the Bill. However, the way the situation unfolded left a bad taste. The absence of any reference to these proposals in the Budget speech, in which a lot of space was devoted to the government's financial sector reform agenda, gave the impression that these measures were sought to be introduced surreptitiously. Given the backdrop of fractiousness between the RBI and the finance ministry, those inclined to conspiracy theories concluded that this was yet another attempt to restrict RBI's domain.
However, it is worth remembering that, though some of these measures flow from recommendations made by the Financial Sector Regulatory Reforms Commission, they do reflect a much longer standing position that all markets and the securities that are traded in them should be regulated exclusively by the Securities and Exchanges Board of India. Still, the merits of this position apart, if the Finance Ministry wanted to implement them, this was hardly the way to do it. The amendments should have been mentioned in the speech, after having informed the RBI that this would be done. As it happened, RBI Governor Raghuram Rajan responded quite strongly, after which the government seems to have backed down.
It is important to look at the substance of these proposals. As far as the government securities market goes, the main reason that the RBI holds joint regulatory responsibility with Securities and Exchange Board of India (Sebi) is the importance of government securities in bank portfolios. The Statutory Liquidity Ratio (SLR) mandates that banks hold 21.5 per cent of their liabilities in these assets. It has been argued that the exemption from mark-to-market requirements for this holding is a significant barrier to the development of an active secondary market for these instruments. If that is indeed a policy objective, which has been often indicated by both the government and the RBI, then there is some merit to the argument that the RBI phase out the SLR and, while doing so, cede regulatory control over this market. In fact, with the establishment of the Public Debt Management Authority, which will take over this function from the RBI, there is no reason for RBI to continue to give the government captive access to bank funds.
The money market, however, is another story. This provides the direct channel of transmission from monetary policy actions to the financial system. There is undoubtedly room for reform to bring about greater efficiency, but it would be rather difficult to visualise the RBI having to conduct monetary policy through channels over which it had no control at all. The repo and reverse repo windows logically belong to the RBI and it must have control over them. In these, as in other items on the financial sector reform agenda, there needs to be a greater sense of comfort that the right things are being done for the right reasons. Substance is critical, but form is not unimportant.