The Reserve Bank and the Government

The proposal of the revised draft of the Indian Financial Code (IFC), put out last month by the Ministry of Finance, that any decision on monetary policy should be taken by the majority in a seven-member committee in which the Reserve Bank of India (RBI) Governor will not have any veto power, is undeniably an attempt to curtail the autonomy of the central bank. The government, when faced with immediate and widespread criticism, was quick to disown the revised draft. It fielded the finance secretary to defuse the controversy, who denied ownership of the document by the ministry, and very disingenuously claimed that as the revised draft IFC was a compilation of public responses, “the people of India owned the draft.” There was no compilation in the revised draft; there was one specific proposal. As a perceptive article in these columns last week pointed out, a well-laid out process for preparing the IFC was overturned by the finance ministry and the initial draft which morphed into the revised draft had the clear imprint of the ministry (“The Indian Financial Code: The Good, the Bad and the Ugly”).

The difference of opinion regarding the conduct of monetary policy between the RBI and the finance ministry may have come out in the open with the preparation of the revised draft code, but this conflict is an age-old dilemma of when to move from a tightening to an easing rate cycle in monetary policy. On this front, the RBI has been under a huge amount of pressure from the government to cut the monetary policy rate, though it has continued to resist such pressure, most recently in the August 2015 policy. Such tension is not new. For example, over the years the government and the RBI seemed to have developed differing opinions on liberalisation of the capital account. The government has often tended to be swayed by the sentiments and the hype of loud voices in the financial markets and has wanted to take a far more liberal view of capital account convertibility so that it can further open the Indian equity and debt markets. The RBI has been largely seen as a spoilsport in this regard, throwing cold water on the equity and bond market party. Consequently, the financial markets have disliked the RBI for obvious reasons and the government, in its zeal to pursue financial market liberalisation, did not like the RBI either.