Is the RBI's Freedom in Dire Straits?

Fri, 20 Jan Pre-Open

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The Reserve Bank of India (RBI) has a crucial role in managing the Indian economy. It is responsible for monetary policy decisions (i.e. setting interest rates) and providing stability to the currency. While doing so, it controls inflation and regulates the financial sector. And this crucial role demands that the RBI and government operate independently of one another.

In other words, the RBI should in no way be influenced by the political motives of the government in power. However, this is easier said than done.

The turn of events in the last year have raised numerous questions on the independence of RBI. Among them the dilution of the powers of RBI's governor, the silence of new governor Urjit Patel, and the demonetisation drama. The central bank has been widely criticised. Even RBI's employee union wrote a letter to the governor expressing its concern over infringement on the central bank's autonomy.

Keeping the debates at bay, do we still believe RBI has redeemed its autonomy?

An article from Livemint illustrates otherwise. It cites a 2014 paper by N. Nergiz Dincer and Barry Eichengreen to show that, compared to 89 of its global peers, the RBI is one of the least independent banks central banks profiled.

The study assessed four factors to decide how independent a central bank is: government intervention in appointing the central bank's head; government intervention in making policy decisions; price stability being the sole or primary goal of monetary policy; and limits on the government's ability to borrow from the central bank.

The RBI has since adopted the inflation targeting framework and created a monetary policy committee (MPC), so it must be faring better. But it's probably still hovering near the bottom of the above list.

So there is no question that the RBI's freedom is at risk.

Its independence is diluted, most of it cashed in by the government.

Take the demonetisation exercise, for example. The government has been center stage in the entire issue - an issue which ideally lies in the domain of the central bank. The government seems to be framing all the rules, and the RBI meekly implementing and following them.

This awkward situation can impede economic growth and investor confidence. It might even drive us into an era of easy money policies such as those of the western world.

As The Honest Truth states...

• The tenure and direction of India's economy over the remaining term of this government's time in power is 3 years. The next scheduled general election is around May 2019.
  
  The Governor of the RBI will also have 3-year tenure till September 2019.
  
  Together, they can create - or destroy - the foundation for growth years into the future.

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