The fault lines between India’s central bank and its government have deepened and are now out in the open.
A debate over the Reserve Bank of India’s (RBI) autonomy, a tussle over interest rates, and the question of who controls the country’s payments ecosystem are some of the latest flashpoints between the banking regulator and the Narendra Modi government.
The RBI has already warned the government of “potentially catastrophic” consequences if it keeps meddling in its affairs. “Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite (an) economic fire, and come to rue the day they undermined an important regulatory institution,” Viral Acharya, deputy governor of the RBI, said at an event in Mumbai on Oct. 26.
Not surprisingly, the government is reportedly very distressed by these public comments. It is feared that the simmering tension has sparked an unprecedented crisis that may spook the stock and currency markets.
Here’s all you need to know about the policy struggle:
Out in the open
Urged by India Inc, the government had been exerting pressure on the central bank to relax certain stringent policies related to curbing bad loans ahead of the general elections next year. While the RBI has been resisting the interference all along, the hushed fight is now a public brawl.
“Unfortunately, not all politicians are thoughtful. Not all have the patience to wait for long-term gains. Not all are pleased when appointees refuse to bow to their wishes. And not all are respectful of inherited institutions and conventions, be they central bank independence or, more broadly, the division of powers,” said Acharya at the Mumbai event.
There were three other deputy governors in the audience. Acharya also mentioned that the suggestion to explore the theme of “independent regulatory institutions” for the speech that day came from Urjit Patel, the RBI governor.
Fault lines
In the last one year, there have been tensions between the two parties regarding the build-up of bad loans in the banking sector.
The government raised objections to some of the measures introduced by the RBI to stem the rise of non-performing assets (NPAs). According to a Feb. 12 circular by the RBI, lenders now need to identify projects with even a day’s default and chalk out a resolution plan within 180 days.
As expected, India Inc was extremely opposed to these new norms and had lobbied to get them relaxed. Even the government believed that the new norms were very harsh and could spell trouble for the state-run lenders, too, that accounted for a lion’s share of the NPAs. The massive cleanup affected the health of the lenders, and 11 public sector banks had to be placed under regulatory supervision, which led to restricted business and in turn affected the banks’ growth as well. This was another sore point for the government.
Despite this, Patel and his team refused to budge from their stance as they were confident that any relaxation would only make the toxic loan problem worse.
Then, in February this year, India’s biggest banking scam broke. State-owned Punjab National Bank (PNB), was defrauded of nearly $2 billion by two diamond merchants over a period of seven years. While the government blamed the RBI for lack of supervision, the latter hit back by demanding more powers to supervise public sector banks.
The government did come under fire for the fraud, but questions have also been raised on whether the RBI can be absolved of blame. As the banking regulator, it did play a key role in supervising the banks and possibly could have had done more to solve the NPA problem more effectively and also address the lapses in the security system which led to the fraud.
The NPA crisis apart, a year ago, the government reportedly tried to arm-twist the central bank to cut interest rates, hoping it would bolster economic growth.
The government had recently also recommended that payments, or transactions done through e-wallets and cards, should be governed by an independent regulator—the payments regulatory board (PRB)—and not the RBI. A move that prompted the central bank to write a dissent note, a rare occurrence.
The government’s appointment of Chennai-based accountant S Gurumurthy to the central bank’s board also contributed to the rift. Before his appointment in August, Gurumurthy had vehemently opposed the RBI’s approach towards containing bad loans.
A history of dissent
Patel is not the only one to be in the line of fire. Previous governors have also been at war with the central government, albeit in a little more subtle way, most of the times.
“RBI is independent within the limits set by the government,” former central bank governor YV Reddy had famously said several years ago.
Then, another former RBI governor D Subbarao also raised the issue of the excessive pressure exerted by the government in his book “Who moved my interest rate?” which was released in 2016. “Is the Reserve Bank independent? I don’t have a binary answer to this question,” he wrote.
Even Patel’s predecessor, Raghuram Rajan, had also openly criticised government policies a few times and had disagreed with the Modi government on several issues. “It is the central bank governor, unlike other regulators or government secretaries, who has command over significant policy levers and has to occasionally disagree with the most powerful people in the country,” Rajan had said in a speech a few days before his term came to an end.
What next
Government officials, as expected, are reportedly unhappy with Acharya’s speech. They believe that it could tarnish the image of the country among foreign investors, the result of which can be unfavourable. Foreign investors have been bearish on India and have already pulled out $5 billion from the Indian stock market in October.
So far, the finance ministry, which is usually quick to engage in a battle with the RBI, has remained tight-lipped. For the first time after Acharya’s frank speech, Jaitley and Patel will come face-to-face in a closed-door meeting of the Financial Stability and Development Council in New Delhi today (Oct. 30).
A test of the central bank’s autonomy might be afoot.
Want to read more from Nupur Anand? Subscribe to Quartz Private Key—Quartz’s premium crypto newsletter, delivered twice weekly.