The Reserve Bank of India needs to be independent to improve the macroeconomic stability, and policies need to be rule-based, the deputy governor Viral Acharya said on Friday.
"To secure greater financial and macroeconomic stability, these efforts need to be extended to effective independence for the Reserve Bank in its regulatory and supervisory powers over public sector banks," Acharya said in a speech.
Acharya’s comments come on the back of government efforts to carve out regulatory powers related to payments and create a separate regulator. Government officials have also been calling for the RBI to relax lending restrictions for some banks that have a low capital base.
"This theme is certainly one of great sensitivity but I contend it is of even greater importance to our economic prospects. I earnestly hope that I have done some justice to his immortal legacy to independent economic discourse and policy-making," he said.
The RBI has made good progress in earning its independence, most notably in the monetary policy framework (changes wherein, along with the Insolvency and Bankruptcy Code and the Goods and Services Tax, were considered as crucial structural reforms by Moody’s in upgrading India’s sovereign rating eleven months back), Acharya added.
"Such endeavour would be a true inclusive reform for the Indian economy’s future. Thankfully, it is only a matter of making the right choices, which I believe as a society we can with adequately thoughtful “what-if” analysis; I have sketched a scenario, which several parts of the world are presently witnessing, of great risk to nations from undermining the independence of their central banks," he said.
As many parts of the world today await greater government respect for central bank independence, independent central bankers will remain undeterred, Acharya said, adding that g
overnments that do not respect central bank 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; their wiser counterparts who invest in central bank independence will enjoy lower costs of borrowing, the love of international investors, and longer life spans. Read the full text of Acharya's speech here Here are the key highlights from Acharya's lecture in Mumbai on Friday
The Reserve Bank, like many central banks of the time, got quickly trapped into the socialist planning policies of post-independence government, setting not just the rate of interest on money but practically all rates of credit at different maturities, as well as doing sectoral credit allocation to the real economy. Post the deregulation of interest rates in the 1990s, monetary policy achieved a more modern dimension. The MPC, two years old since, has attempted steadfastly through its rate-setting decisions to build credibility of the inflation target, a process that is generally believed, and empirically documented, to help lower the long-term bond yields as well as stabilise the
On Monetary Policy:
On Debt Management:
For several decades post-independence, the Reserve Bank participated in short-term Treasury Bill issuances of the Government of India (bearing extraordinarily low interest rates) to fund its fiscal deficits. The Reserve Bank also publicly acknowledged that its open market operations (OMOs) were primarily geared to manage the government bond yields. This implied that the central bank balance-sheet was always available as a resource – just like tax receipts – ready to monetise excessive government spending. Unsurprisingly, high inflation in India was engineered to please both Milton Friedman and Thomas Sargent, i.e., it was always both a monetary and a fiscal phenomenon, as these two Nobel laureates in economics had respectively argued.
Exchange Rate Management:
In the Five Year Plans post-independence, prices including the exchange rate were assumed to be constant; however, since the true value of the Rupee fluctuated with market prices and macroeconomic conditions, the Sterling holdings had no choice but to take an undue hit. The underlying true value of the Rupee was also affected heavily –– but not reflected in reality –– by monetary policy and debt management operations that were implicitly supporting the ballooning of government deficits. The result of the fixed exchange rate regime in the midst of “fiscal dominance” was that the Reserve Bank was essentially a silent spectator in the build-up to the inevitable exchange rate disequilibrium (though arguably this was true of much of the world at that time). The Reserve Bank deploys reserves management and macro-prudential controls on foreign capital flows to manage excessively large movements. With a flexible inflation targeting mandate for interest-rate policy and funding of fiscal deficit no longer the objective of monetary operations, the desired exchange rate management rests with the Reserve Bank.
On Ongoing Challenges in Maintaining Independence of the Reserve Bank of India Few important pockets of persistent weakness, however, remain in maintaining independence of the Reserve Bank. Some of these areas were also identified in the 2017 Financial Sector Assessment Programme (FSAP) of India by the International Monetary Fund (IMF) and the World Bank (WB) as ways to strengthen the independence of the Reserve Bank, an area in which
the FSAP rates India as “materially non-compliant”.
Regulation of Public Sector Banks:
One important limitation is that the Reserve Bank is statutorily limited in undertaking the full scope of actions against public sector banks (PSBs) – such as asset divestiture, replacement of management and Board, license revocation, and resolution actions such as mergers or sales –– all of which it can and does deploy effectively in case of private banks. The significant implications of this limitation were highlighted in detail in Governor Patel’s speech in March 2018, Banking Regulatory Powers should be Ownership Neutral.
Having adequate reserves to bear any losses that arise from central bank operations and having appropriate rules to allocate profits (including rules that govern the accumulation of capital and reserves) is considered an important part of central bank’s independence from the government (see, for example, Moser-Boehm, 2006). A thorny ongoing issue on this front has been that of
On The Reserve Bank’s Balance-sheet Strength:
the rules for surplus transfer from the Reserve Bank to the government (Cogencis, 2018, “Govt pegs RBI excess capital at Rs 3.6 trillion, seeks it as surplus”), an issue that relates closely to the leading Argentine example in my introductory remarks.
A final issue is one of regulatory scope, the most recent case in point being the recommendation to bypass the central bank’s powers over payment and settlement systems by appointing a separate payments regulator. The Reserve Bank has published its dissent note against this recommendation on October 19, 2018.
With inputs from Reuters.