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Last Updated : Jan 14, 2019 06:14 PM IST | Source: Moneycontrol.com

Modinomics — Monetary policy reforms in light of strained RBI-FinMin relations

The RBI’s relationship with the government has been anything but cordial, more so in the last few months.

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It would not be entirely incorrect to say the Reserve Bank of India (RBI) and issues that it deals with have become part of the mainstream conversation over the last four years.

Time was when RBI board meetings were hardly considered headline- worthy to make it to the front pages.

Not any longer.

The festering tension between North Block and Mint Street have meant the phraseology of discussions on “Section 7”, the RBI’s autonomy, governor’s resignations, governor’s education, the RBI’s capital surplus and a new economic capital framework of RBI and jurisdictional issues have dominated interest among the media and the commentariat

On December 10, 2018, Urjit Patel resigned as the RBI governor, ten months before his tenure was to conclude in September 2019, ending a 28-month long stint at Mint Street rocked by a testy debate on the central bank’s autonomy.

Patel’s resignation came four days ahead of the RBI’s scheduled board meeting on December 14, slated to discuss several contentious issues. Patel cited “personal reasons”, but it was anybody’s guess why he chose to pull the plug.

The RBI’s relationship with the government has been anything but cordial, more so in the last few months.

Patel’s deputy Viral Acharya first flagged the government’s reported attempt to tread onto the central bank’s territory.

The RBI Act, the key legislation that defines the central bank's functioning, role and reporting relationship with government, has become part of living room conversations, with a strong body of opinion on both sides of the fence.

Patel took over as the RBI governor on September 4, 2016, after serving nearly four years as deputy governor, carving out a role of a 'go-to' person on key policy matters for Raghuram Rajan, his immediate predecessor as India’s central bank chief.

Rajan, who left for the US to don the academic robe again after his three-year term ended in 2016, had repeated run-ins with the government and did not dither to comment on non-economic and non-central bank related matters.

Globally, most central banks have one principal responsibility: to guide the course of money and credit. The RBI, however, has to carry out a few other tasks: it is the banker’s banker, the government’s debt manager and lender of last resort as well as the banking regulator. Some of these roles can pull the central bank in opposite directions.

It is anybody’s guess which of these functions Rajan or Patel would have found the most challenging and the most rewarding in the last four-and-half years.

Unlike his predecessor Raghuram Rajan who had the final say on interest rate cut decisions, Patel had to go by the advice of a newly-set up six-member monetary policy committee (MPC), billed as the biggest monetary reform measure in a generation.

In February 2015, the government and the RBI agreed to adopt a monetary policy framework that made cooling inflation the central bank’s main priority.

The RBI and the government have set a retail inflation target of four percent for the next five years with an upper tolerance level of six percent and lower limit of 2 percent. Inflation levels above six percent will mean the economy has hit a danger zone.

High inflation means prices are rapidly rising eroding people’s buying power as it makes the rupee go less far. Conversely, very low inflation levels can be symptomatic of an economy-wide slide because of low demand and muted investment activity.

The move is primarily aimed at eliminating speculation in RBI’s interest rate decisions. The RBI has to juggle many roles, and, on many occasions, it can lead to a conflict of interests.

For instance, when inflation is rising the central bank is generally expected to raise interest rates to slow down demand and tame price rise.

But, the RBI is also the public debt manager. In its capacity as the government’s sole merchant banker and sovereign bond regulator, its aim is to maintain low interest rates.

The new framework removes such ambiguities by making inflation targeting the central bank’s primary focus. Effectively, it implies that RBI will choose inflation management as its first choice should a toss-up were made between multiple goals.

Under the new monetary policy framework, a six-member panel chaired by the RBI governor decides on interest rates. The decision of the committee – three each nominated by the government and the central bank – will be binding.

The governor cannot override the panel’s decision by using a veto but can cast a vote in the case of a tie.

On more occasions than one since 2014, the RBI had made clear its unease about North Block’s (Finance Ministry) attempts to get overbearingly close to Mint Street (RBI), though it stoically carried out shock demonetisation move, becoming the principal executing agency of the world’s largest currency culling exercise.

It was pitched as government’s broad strategy to clamp down on India’s bustling parallel economy by launching an attack on the hidden wealth held in undisclosed cash. The move triggered howls of protest as serpentine queues outside ATMs became a lasting image of the currency recall plan.

A day after Patel’s resignation, the government appointed Shaktikanta Das, a member of the 15th finance commission and former economic affairs secretary, as the RBI governor.

Das, who retired as the economic affairs secretary in the finance ministry in February 2017, had become the face of demonetisation, the surprise move to outlaw Rs 500 and Rs 1,000 notes from the midnight of November 8, 2016.

He, along with Patel as the RBI governor, was tasked with the responsibility of carrying out the currency withdrawal exercise.
First Published on Jan 14, 2019 05:56 pm
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