It is unfortunate that RBI, through deputy governor Viral Acharya’s speech, came out so strongly against the government last week, and the analogy he started the speech with was worse. While public airing of bad blood between the government and the central bank must always be avoided given the impression it gives market participants, Acharya talking about how Argentine bond markets taught the government a lesson after it transferred $6.6bn from the central bank to itself seemed like it was an invocation to Indian bond markets should the Modi government succeed in getting a larger share of RBI’s reserves. That said, restraint is not something that just the RBI needs to be practicing; the government’s sniping at RBI is quite public and the constant questioning of RBI’s stance on reining in various public sector banks through the use of its Prompt and Corrective Action (PCA) is unfortunate since it makes it clear the government doesn’t trust the RBI’s view.
And while the general impression being given by the government is that RBI has been sleeping on the job – and it is this that the government is trying to fix – it would be a very brave man who would say only the central bank’s actions are causing a problem. This newspaper believes RBI raising repo rates hurts the economy – most others don’t subscribe to this view – but rates go up even when government borrows too much, even if through surrogates since bond markets recognize this for what it is – FE estimates Rs 1.7 lakh crore of ‘extra budgetary resources’ will be raised in FY19. And if, as the government says, RBI is guilty of not being able to detect the bad loans of banks in time or figure out the mess in IL&FS despite it being a systemically important NBFC, surely most of this applies to the government as well? As the owner of the PSU banks, it needed to know what was happening and that is why it had its directors on these banks. As for IL&FS, apart from RBI, others who failed to figure out what was happening were members of the Financial Stability and Development Council which is headed by the finance minister and includes many finance ministry bureaucrats; more important, the top shareholders of IL&FS include LIC, SBI and Central Bank of India.
This is not the first time RBI and the government has clashed, and it is certainly okay for the government to have a different view from the central bank on PCA and other issues. But no regulator can work if its views are constantly questioned by the government in public. A better way sought out these differences, and to come to a conclusion which is what really matters, is to have a larger debate with technical experts weighing in. When then CEA Arvind Subramanian recommended sequestering a part of RBI’s reserves as they were “excess” and then RBI Governor Raghuram Rajan said this displayed a lack of understanding of how RBI functioned, the government should have converted this into a larger debate; trying to get its way in a boardroom brawl at the RBI, as is happening right now, makes little sense since not enough experts have weighed in on the issue. Surely, a weak RBI without enough funds to carry out its essential tasks cannot be something the government would want, no matter how cash-strapped it is right now? The government would similarly benefit if there was a larger debate on whether the PCA framework should be relaxed; after all, if these banks had collapsed as they kept lending indiscriminately, the country would have been in the throes of a full-blown financial crisis.
Given how the financial system looks shaky with the banks still not out of the woods and IL&FS threatening to make things far worse, and not just in the banking sector, the country needs both RBI and the government to work together, not snipe at one another. Though this newspaper disagrees with inflation targeting as a policy, as Acharya has pointed out, when government and RBI have worked together, they have come up with strong policies they have both agreed upon – he mentions inflation targeting and stopping the automatic monetization of government deficits as two success stories. Finance minister Arun Jaitley would do well to initiate this patch up instead of leaving it to his bureaucrats who are only making things worse. While RBI would benefit from larger consultations as the FM has suggested, his statement that regulators aren’t accountable while politicians are would suggest it is time to wind up all regulatory bodies; that cannot have been his intention.