Urjit Patel resignation talk underscores one of the worst RBI-govt spats in history

CNBC-TV18 also reported that there was an "irreversible breakdown" between the government and the governor and that "all options are on the table" for the governor.

The government is reportedly upset with some of the RBI's decisions, including its move to restrict lending by NPA-laden banks under the "prompt corrective action" framework.

It also wants the RBI to transfer some of its reserves to the treasury because it believes that the central bank holds excessive reserves.

On October 30, Finance Minister Arun Jaitley publicly criticised the RBI's conduct during the UPA era, for "looking the other way" as banks lent recklessly.

Last week, RBI Deputy Governor Viral Acharya, in a speech, talked about the importance of maintaining the RBI's autonomy, saying any efforts to undermine it would "incur the wrath of financial markets and ignite an economic fire".

Adding fuel to the fire were reports this morning that the government has decided to invoke Section 7, which allows the government to issue directions to the RBI governor "in public interest".

The decision, if taken, will become political fodder for the government's opponents. Former finance minister P Chidambaram was quick to point out that the law had never been invoked before.

If, as reported, Government has invoked Section 7 of the RBI Act and issued unprecedented ‘directions’ to the RBI, I am afraid there will be more bad news today

— P. Chidambaram (@PChidambaram_IN) October 31, 2018

We did not invoke Section 7 in 1991 or 1997 or 2008 or 2013. What is the need to invoke the provision now? It shows that government is hiding facts about the economy and is desperate

— P. Chidambaram (@PChidambaram_IN) October 31, 2018

Later in the day, the government issued a statement saying that autonomy for the central bank, within the framework of the RBI Act, "is essential" and an "accepted governance requirement".

"Governments in India have nurtured and respected this. Both the Government and the central bank, in their functioning, have to be guided by public interest and the requirements of the Indian economy," the statement said.

"For the purpose, extensive consultations on several issues take place between the government and the RBI from time to time. This is equally true of all other regulators. The government of India has never made public the subject matter of those consultations. Only the final decisions taken are communicated. The government, through these consultations, places its assessment on issues and suggests possible solutions. The Government will continue to do so."

The RBI is yet to issue a response.

Autonomy for the central bank

The issue of the RBI's autonomy is nuanced, with experts saying that while the RBI does not enjoy full autonomy and is answerable to the government and Parliament, the Executive is expected to grant functional autonomy to it.

Functional autonomy can be described as the government outlining the framework within which the RBI is free to operate. The inflation targeting regime introduced by the current government, under which the RBI has a mandate to keep inflation around 4 percent (with a range of plus or minus 2 percent), is an example of this.

The current government also brought in the monetary policy committee (MPC), a global best practice that allows a panel to take interest rate decisions.

But the constitution of the committee too was fraught with some controversy, with some accusing the government of wanting to impinge on the RBI’s authority to take rate decisions.

Eventually, a six-member committee was formed, with three nominees each from the RBI and the government, and the governor retaining a casting vote in case of a tie.

Past cases of RBI vs govt

Relations between the RBI and the government have often been frosty in the past. The two parties can have objectives that are at odds: the central bank may be focused on containing inflation while the government may want a monetary policy environment more conducive to growth.

The root cause for these tensions is that while elected governments typically have a short-term view, central banks have to take a long-term view to ensure financial stability.

Over the past few decades, stories of friction between the two have become legend.

YV Reddy famously did not see eye-to-eye on several issues with the finance ministers of his time -- Jaswant Singh and Chidambaram.

Chidambaram also made public his grievance with the monetary policy stance adopted by Reddy's successor D Subbarao, saying his government "would walk the path of growth alone" if the RBI was not inclined to cut interest rates.

The current government did not give an extension to the previous RBI governor Raghuram Rajan amid reports that it wasn't happy with Rajan's interest rate policy, and his public, often controversial, remarks on non-economic issues.

Later, reports also said that Rajan was not in favour of implementing demonetisation, which was announced two months after Urjit Patel took over at the helm.

In the 50s, the fourth RBI governor, Benegal Rama Rau, resigned amid differences with the then finance minister TT Krishnamachari.

(Updates: Incorporates government's response.)