Lack of Autonomy of India's Central Bank

Tensions have been growing between Prime Minister Narendra Modi and India’s central bank, the Reserve Bank of India (RBI), for the past few months. Recently, a speech given by a top RBI official revealed the extent of the dispute, concerning India’s monetary policy and control over RBI’s reserves. While India’s economy has grown, there still exist significant problems. The government has repeatedly demanded that the Reserve Bank of India (RBI) hand over substantial amounts of money from its $50 billion reserves to assist the government fund its fiscal deficit. In addition, the Modi government wants the RBI to lessen its lending restrictions on 11 state-run banks. These measures were imposed because the banks had major debt problems, and the RBI plans to continue the measures until the banks can become profitable and reduce their substantial debt levels. Modi’s administration alleges that the restrictions are too strict and have reduced the ability of small- and medium sized businesses to acquire loans.

The main source of the conflict seems to be the RBI’s belief that the governments demands for access to its reserves amounts to “raiding”. In a meeting late October, deputy governor of RBI Viral Acharya said that “Governments that do not respect central bank independence will sooner or later incur the wrath of the financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution.” These harsh words were followed the next few days by reports that the government was planning to exercise never-before used powers to influence the bank’s decision making. These “directions” would be in the public interest, supposedly. This past Wednesday, rumors began that Governor Urjit Patel, the bank chief, would possibly resign over this dispute with the government. Should his resignation materialize, it would be the first time a serving chief leaves his job midway through his five-year term.

This dispute is arriving at a tense time for the Modi Administration. With a general election rapidly approaching early next year, some believe that the government is attempting to spend big to stimulate the economy to attract voters. However, the Modi government currently possesses very little in the budget to go on a new public spending spree. Revenues have fallen despite attempted policies such as the currency ban in 2016 or the goods and services tax. These measures have not succeeded as well as previously hoped and the Modi government is quite cash-poor. This is also in part due to the expensive rollout of Modi’s ambitious health insurance plan for India’s poorest, which cost $300 million in its first year, and is projected to cost up to four times as much every year. There exists very little in the budget for increased spending, which is why many have looked at this dispute with the RBI as a blatant attempt to boost the government’s image leading into the election.

Disputes between national governments and central banks are not uncommon. However, with India being the world’s sixth largest economy, the potential consequences of Patel’s resignation could be massive. India’s economic future is already struggling somewhat, with the rupee falling by 15% against the dollar this year, and doubts about whether the previously impressive growth can continue. If this dispute between RBI and the government continues and culminates in Patel’s resignation, it would bode ill for India’s economic future, and private investment might decrease.  Private investment has increased in recent years in part due to a persistent fall in the inflation rate since 2014. However, indicators that the government can overtly influence RBI actions is likely to remove such confidence.

 While the Finance Ministry said in the statement on Wednesday that it respects the autonomy of the RBI, many still believe that Patel may resign. Interestingly, a top ally of Modi has come out in strong support of Governor Patel. Subramanian Swamy, whose criticism of previous bank chief Raghuram Rajan contributed to Rajan not seeking a second term in 2016, recently tweeted that Patel should be “persuaded to stay”, clearing voicing his support for the besieged bank chief.

 

Governor Patel has called for a meeting of the bank board for November 19th. It is unknown if he plans to submit his resignation at this meeting or not. The government has stressed its desire for confidentiality regarding communications between RBI and the Modi administration, but these debates have a tendency to enter the public knowledge.