Former RBI Governor Speaks Out on Central Bank Autonomy

Former central bank governor YV Reddy says there is no doubt the government has a claim over the RBI’s reserves, but questions how it is exercising its claim.

Former RBI (Reserve Bank of India) governor YV Reddy has criticised the government for intervening in central bank affairs, terming its latest actions taken to obtain dividends from the RBI as “coercive monetisation of fiscal needs”.

In a speech delivered at the Gokhale Institute of Politics and Economics on Saturday (9 February), Reddy spoke about the recent tensions between the government and central bank, which culminated in the resignation of governor Urjit Patel in December.

Of particular significance, he said, was the October 2018 proposal to invoke Section 7 of the RBI Act – which empowers the government to issue directions to the RBI governor – an “unprecedented move”. The Section 7 provision has never been used out of respect for the central bank’s autonomy.

“In many ways, this raises fundamental questions on governance” and “virtually meant that the channels of normal communication for reaching agreed position between government and governor RBI had broken down,” Reddy said. “The resolution of issues originally flagged for consideration under Section 7 are likely to impact the future role of RBI.”

On the issue of the RBI’s excess reserves, Reddy said there is no doubt that the government has a claim over the reserves, but he questions the way in which it exercises its claim.

“While a Committee is examining Government’s claim on the accumulated reserves of RBI, including those on account of revaluation, it has been reported two days ago that RBI is being asked to pay to Government as dividend the amounts that have been transferred to reserves in the previous two years,” he said, referring to the INR 280 billion (USD 3.93 billion) the government has said it expects from the RBI in interim dividends for each of the last two years.

“The immediate fiscal needs seem to take precedence over a renewed assessment of the capital needs of RBI,” he said, which marks a departure from the government’s actions in 2013, when it shared the cost of sterilisation to ensure the central bank balance sheet remained strong.

In addition, Reddy said the government demands for a relaxation in the RBI’s PCA (Prompt Corrective Action) framework – which imposes restrictions on weak banks until they achieved preset capital and liquidity requirements – dilutes both the autonomy and accountability of the central bank.

He was also against the government’s demands to dilute bank capital norms in India, which are seen to be more stringent than the global standards. There is a case for Indian norms to be more stringent, Reddy explained, as Basel III norms assume a particular level of realisable value. In India, transaction costs and liquidity make the realisable value generally far less than the declared value, he said.

With regard to liquidity conditions at NBFCs (non-banking financial companies) – another point of friction between the government and the RBI – Reddy noted that the case of IL&FS was an insolvency issue rather than a question of liquidity. The government’s concern, he said, stemmed from state-owned institutions LIC (Life Insurance Corporation) and SBI (State Bank of India) holding large stakes in IL&FS. The RBI, on the other hand, should be concerned about the risk assessment capabilities of such public sector giants instead.

In addition, Reddy said the government’s urging for aggressive lending to SMEs could jeopardise depositors’ interest or induce systemic instability, and that any extra support to the segment should come from budgetary resources – not from the central bank.

Finally, on the issue of governance and the role of RBI’s board, Reddy said the current board composition is appropriate, despite the government’s attempts to make it more assertive.

“There is one lesson from the past to guide us,” he said. “RBI has done well whenever it has the liberty to think globally, advise independently and act in the domestic context.”

The full speech is available here, compliments of Bloomberg.

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