RBI’s Subservience to the Government Is Systemic, Not Ideological

The autonomous functioning of the Reserve Bank of India has been, if anything, an exception rather than the rule.

Recent investigations have revealed that the Modi government dismissed, and overruled, the Reserve Bank of India’s (RBI) reservations with respect to the issuance of electoral bonds in 2017. In an ideal scenario, a strong opposition by the RBI to the government’s suggested amendment to the RBI Act, 1934 would have led to further debate on the matter. However, as has been shown, the government chose to go ahead with the amendment that would allow electoral bonds to become a reality, and passed the Finance Bill, 2017. This overruling on part of the Modi Government has once again brought into the limelight, the discord between the government and the central bank. 

There have been three high-profile exits from the RBI in the post-2014 Bharatiya Janata Party regime so far. Raghuram Rajan’s departure from the post of Governor of the RBI in 2016 was followed by that of his successor, Urjit Patel, in 2018 and the Deputy Governor, Viral Acharya, in 2019. All three departures instigated controversial spats and vehement debates regarding the autonomy of the RBI. 

While Raghuram Rajan largely remained tight-lipped regarding the circumstances of his departure, he was deemed to not be in sync with his Indian roots by members of Parliament at the time. Similarly, although Urjit Patel tendered his resignation citing “personal reasons,” it came against the backdrop of a protracted mud-slinging match between the Ministry of Finance and the RBI. Viral Acharya’s resignation just six months before his tenure’s end, also citing “personal reasons,” was seen as a natural culmination given the rise in disagreements between the centre and the RBI that Acharya was vocal about in his speeches in the days leading up to his exit. 

In his speech, the most explicit indictment of the government’s excessive, and perhaps obsessive, need to control the reins of the RBI in recent times, Acharya mentioned:

Governments that do not respect [the] central bank's independence will sooner or later incur the wrath of financial markets, ignite economic fire and come to rue the day they undermined an important regulatory institution.

However, such instances are not particular to the current political regime. The autonomous functioning of the RBI has been, if anything, an exception rather than the rule. In this reading list, we chart the relationship between the RBI and the government since its inception, as well as the systemic overhaul that is required for the RBI to attain its much sought-after autonomy. 

The RBI and the Government: A "Hindoo Marriage"

Charting the origins and functioning of the RBI, Anand Chandavarkar observes that since its inception, the RBI has been seen as a section of the finance ministry, rather than an independent institution unto itself. Further, with the antagonism between finance ministers and governors commonplace, the only time RBI truly enjoyed functional autonomy was during World War II, primarily due to the “rare understanding” that was displayed by Jeremy Raisman, then Finance Member of the Government of India. Chandavarkar notes that the institution of the RBI itself has been founded on the principle of subservience, with Montague Norman, Governor of the Bank of England, conceptualising the relationship between the Bank of England and the RBI as a “Hindoo Marriage.” This, later, found its way into the manner in which legislation pertaining to the functioning of the RBI was framed.

On the eve of setting up the RBI, Montague Norman, the legendary governor of [the] Bank of England, contemplated ‘a Hindoo marriage’ between the Bank of England (the dominant spouse) and the RBI (the subservient wife), whereby in return for formal advisory services, the RBI was to yield to the Bank of England the right to determine the disposition of its funds and generally cooperate with it in matters affecting the good management of sterling. Norman’s graphic simile is even more expressive of the RBI’s real status after its creation. The GoI became the male chauvinist husband and the RBI the ever docile traditional Hindu wife who had forfeited even the minimum right of nagging the husband– the supreme prerogative of a central bank, as so memorably stated by Norman himself. The pre-1934 sacramental marriage was formalised by the RBI Act of 1934, which ensured that all the critical initiating and overriding discretionary monetary powers were vested with the GoI.

The Prophetic Tale of the First Governor 

In an attempt to fill the gap in the official and academic literature on the history of the RBI, Chandavarkar explores the abrupt resignation of Osborne Arkell Smith, the first Governor of RBI, two years before his term was to expire. Chandavarkar notes that the hostility between him and Percy James Grigg, then Finance Member to the Viceroy's executive council, was largely related to their differences in policy perspectives with respect to the role of the RBI as a lender of last resort and the conduct of monetary policy. These differences manifested themselves in the way Grigg chose to deal with Smith. Grigg continuously chose to subvert Smith's authority by breaching the proper channels of communication, and instead, send important telegrams directly to the Deputy Governor, James Taylor, even when Smith himself was available. 

Additionally, the appointment of Smith’s two deputy governors, James Taylor and Sikander Hyatt Khan, was itself unilaterally decided by Grigg based on his own personal and political requirements, rather than technical competencies. The troubled equation between Grigg and Smith, along with the latter’s abrupt resignation, was further echoed in the 1950s with the resignation of Rama Rau, then Governor, whose exit from the role was a protest against Finance Minister Krishnamachari’s public criticism of him and the RBI. 

... Central bank independence itself is a highly ambiguous concept susceptible to differences of kind and degree. Thus, one can differentiate between: de jure and de facto independence; constitutional and statutory independence; instrument and target independence. Each of these subsets implies fine gradations of independence. Although the RBI Act of 1934 did not confer statutory independence on the RBI, Grigg undermined even the minimal independence of the RBI at the very outset by not consulting Smith in the selection of his two deputy governors, Taylor and Sikander Hyat Khan. Taylor had at least the right credentials for the European vacancy with his experience of the ICS and generally of government finance, even though he lacked any knowledge or experience of the money market and the gilt-edge market. But the choice of Sikander Hyat Khan, a Muslim, for the Indian vacancy was singularly unfortunate as he lacked any experience of banking, business, or finance and his so-called administrative experience was confined to a brief spell as acting governor of the Punjab. Like Taylor, he was completely malleable to Grigg’s manipulations, and his selection was a manifestation of pure political expediency.

Denouncing Viswanathan’s attempt to write off this conflict between Grigg and Smith as a dramatic personal spat, Chandavarkar observes that the differences between the two were in line with the historical data on other central bankgovernment conflicts wherein the individuals acted as proxies in the greater face-off between institutional powers.

Historically, central bank–government conflicts, insofar as they are made public, have always involved the Governor (qua central bank), and the finance minister (qua government) in their representative and not personal capacities. A telling example of this is the historic conflict in Canada (1961) between Governor John Coyne and the finance minister, Donald Fleming, which led to an alarming depreciation of the Canadian dollar and subsequent resignation of Coyne. Although, neither Grigg nor Smith thought it fit to involve their respective collegiate entities, the Executive Council (GoI) and the Board of Directors (RBI), in their prolonged conflict, this does not transform it into a personal feud.

Requirement of a Systemic Overhaul

Y V Reddy looks at the relationship between the RBI and the government since independence, dividing them into four phases, that is, 195070, 197090, 19902010, and post2010. Tracing the origins of the erosion of RBI’s autonomy to the first period itself, Reddy’s timeline goes into detail about the largely subordinate position of the RBI with respect to the government through every period. However, Reddy observes that the takeaway from the history lesson is the RBI’s ability to do well when it takes independent decisions. This would require a systemic overhaul of the way in which the RBI has been conceptualised and the powers it has been allowed, both on paper and in practice. Such an overhaul would be all the more important in the coming years when India’s position in the global economic arena would gain importance. 

Perhaps, in regard to India also, we are going through confusion in search of a new ideal for a central bank and it has to be ideal for our circumstances. There is one lesson from the past to guide us. The RBI has done well whenever it has the liberty to think globally, advise independently and act in the domestic context.

Chandavarkar notes that, over the years, the RBI alone has remained immune to any kind of economic reform, following the global trends of legal independence and modernisation of central banks. Additionally, there is a complete lack of monetary federalism in the architecture of the RBI. This, he argues, goes against the letter and spirit of federalism enshrined in the Constitution of India. Not only is it absent in practice, there is also a glaring silence on the subject when exploring the public discourse. 

Incorporating such a model of monetary federalism would include addressing systemic issues such as the security of tenure for the governor and the constitution of the executive Monetary Policy Committee (MPC). These require strong political will to change the very way in which the RBI has been envisioned to function. For example, though the RBI Act, 1934 defines the terms and conditions of office and disqualifications for the governor, it does not stipulate the qualifications required for the job.  With regards to the MPCs, even though the RBI’s Technical Advisory Committee on Monetary Policy is an advisory, it remains an opaque entity. This is unlike the transparent executive MPCs of other reformed central banks over the world, and to this end, would serve no substantive purpose unless morphed into an empowered executive committee whose proceedings and voting records are made public. 

The overdue modernisation of the RBI requires a clear-cut legislative formulation of its non-hierarchical objectives, constitutional independence, coordination with the GoI, accountability, transparency, and governance reforms. This would also close India’s democratic deficit and incorporate monetary federalism. The benign neglect of these long-standing issues reflects a discredited Fabianism of the inevitability of gradualness. The complexity of the issues warrants appointment of a high-powered non-official commission of inquiry reporting to the prime minister within an expeditious time-frame. One can only hope that “the draft law already pending” to “sanctify the kind of autonomy being practised by the RBI” will not prejudice the appointment of the proposed commission.


Read More

RBI Autonomy in Historical Perspective | Tapas Kumar Chakrabarty, 2006

RBI: Old and New | Mary George, 2013

Government and RBI: No Real Stand-off over Macro Policy | C P Chandrasekhar, 2015

Government versus RBI | EPW Editorial, 2018

What Should be the Criteria for Choosing RBI Governor? | Vivek Moorthy, 2016


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