Is Reserve Bank Of India’s Autonomy Under Threat?

India's economic policy-making continues to face hurdles.

A growing rift between the Indian government of Prime Minister Narendra Modi and the Reserve Bank of India (RBI) shows why central-bank autonomy is important—and difficult—when it comes to good economic management.

India’s central bank enjoys operational autonomy under the RBI Act of 1934. Modi’s regime is seeking a say in policymaking and management of reserve funds—currently valued at 9.6 trillion rupees ($136 billion). At one stage, Finance Minister Arun Jaitley threatened to invoke a law that allows the government to issue directions to the reserve bank governor if needed for the “public interest”—an 84-year-old law that has never been exercised.

“Governments that do not respect central-bank independence will sooner or later incur the wrath of financial markets,” cautioned RBI deputy governor Viral Acharya, in an October speech to industrialists in Mumbai. “[They will] come to rue the day they undermined an important regulatory institution.” The administration has complained that the central bank has not done enough to ensure financial-market liquidity and double-digit growth.

A meeting RBI governor Urjit Patel had with Modi in early November and a marathon 9-hour meeting of the bank’s central board seem to have brought about a temporary truce. RBI will set up a panel to suggest policy on management of reserve funds. The bank also acceded to demands to restructure and to offer fresh loans of up to $3.5 million to small businesses. RBI and the government will initiate a drive to recapitalize and create capital buffers in state-run banks to deal with stressed assets. However, there’s no clarity on the policy toward nonbank finance companies that face a serious liquidity crunch.

While temporary calm prevails after both RBI and the government have backed off, the larger issue of the central bank’s independence remains unsettled.