The Hindu Business Line : Does the RBI need revamping?

With the rise of India as a global economic player and its financial stakes assuming mammoth and complex proportions, the scope and functions of the Reserve Bank of India need to be put on a sound footing. Emerging challenges such as financial sector and market stability and enlarging the concept of accountability through greater recourse to transparency all need a strong, independent central bank, says B. S. Raghavan.

Banking on a make-over to make an impact globally.

THE RESERVE Bank of India (RBI) has just completed the Biblical span of three score years and ten, having been established in 1935 on the avoidable date of April 1, pursuant to the Reserve Bank of India Act, 1934. The Act stipulated the function of the RBI to be "...to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." Since the Act was passed during the colonial period, the RBI, as a private "body corporate" was taken to be the appendage, and under the tutelage, of the Bank of England and the British Treasury.

As a corollary of this remote control, the government reserved to itself the power to have the final say by incorporating in the law the right to give directions to the Bank on any matter it thought fit as also to appoint and remove the Governor and the Central and Local Boards of Directors at will.

In delineating the function also, it half-heartedly vested in the Bank a constricted role without entrusting it in explicit terms with responsibilities (other than issuing and administering the circulation of the currency) which are commonly assumed to fall within the purview of central banks: Formulating and implementing monetary policy; maintaining payment and settlement system, managing foreign reserves; acting as banker to the government, and being a player on the international financial stage.

Contrast this with the US Act of 1913 under which the Federal Reserve enjoys a comprehensive mandate to "maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates," besides performing other familiar services such as "furnishing" an elastic currency, rediscounting commercial paper, and establishing an effective supervision of the country's banking system.

The RBI Act came into effect at the same time as the Government of India Act, 1935. Although notionally the Central and Provincial Governments, and the Legislative, Executive and the Judiciary branches, had their separately designated jurisdictions, for all practical purposes, British India was governed as a single administrative entity subject to the fiat of the Secretary of State for India, the Viceroy (Governor-General) and Provincial Governors. In such a dispensation, no institution, not the least the RBI, could take exception to its being treated as a sidekick of the government.

Developmental and promotional activities

After Independence, with the nationalisation of the RBI in 1948, followed by the adoption of the new Constitution in 1949, the emergence of India as a Republic in 1950, and the ushering in of parliamentary system of democracy, the functions of the RBI could not escape spilling over into areas beyond what were strictly pertinent to a central bank.

Thus, the RBI, in addition to looking after the monetary part of the economy, regulating and supervising the financial system, managing the foreign exchange and being the lender of the last resort, had perforce to undertake a number of developmental and promotional activities in line with government policies aimed at creating a welfare state. The RBI has also been under relentless pressure to ensure adequate credit flows to what the government regards as priority productive sectors.

Aligning its monetary prescriptions to the government's interests and goals has necessarily entailed stepping out of the four corners of its charter. It already had had to assume full ownership of the National Housing Bank and the National Bank for Agriculture and Rural Development, with neither of which it should be ordinarily concerned.

It has had to take upon itself the control and supervision of all kinds of banking and non-banking financial companies and the manner of use of their assets. In effect, it could not avoid being, sometimes an agent, sometimes a collaborator, sometimes the escape-latch and the lightning rod, of the government of the day, and, in the bargain, has had to soft-pedal its own decided views on issues and problems affecting the economy.

Rationale for reform

The end-result is the blurring of the boundaries of monetary and fiscal domains, and this miasma of a mishmash threatens to whittle down the RBI's credentials as a pure monetary authority, which, according to some eminent economists and academics, should be on a par with the other three branches of the government, with a mandate to lay down its own priorities and frame its own independent policies immune from the transient compulsions of competitive electoral politics.

In their view, nothing less than a radical revamping of the RBI can restore to it the primacy that is its due as the guardian of the monetary aspects of economic management. They base their espousal of immediate reform on three substantive arguments.

The first is that the RBI has had to spread itself too thin just in order to pull the government's chestnuts out of the fire.

There is also a fear that it is allowing itself to be used as a trouble-shooter on the fiscal front, instead of being an assertive prime mover in proactively putting in place an appropriate monetary framework and testing and monitoring its effectiveness from time to time. It is seen as having gradually slid into the position of an advisor, whereas it was meant to be an autonomous arbiter in its capacity as the supreme monetary authority.

Second, the RBI's constitution and complexion date back to the times when British Parliament and the colonial government were all-powerful and all-pervasive, reducing the RBI to a mere issuer of notes and coins and supervisor of banking and currency operations.

Conceptual distinctions such as between autonomy and subservience, federal and unitary, fiscal and monetary, were not the subject-matter of contention in official circles or public forums. Now, India is a federal polity, in which the Centre and States have their own bounds determined by the Constitution.

The stages and pace of development, the budgetary profiles and the financial resources differ from State to State, but it is a moot question whether the RBI is sufficiently equipped to provide solutions to fit these differences.

Third, functional and operational independence to formulate and implement policies attuned to particular scenarios, without being buffeted by political winds, is essential in its own right in the case of an organisation like the RBI. The Board for Financial Supervision and the Technical Advisory Committee on Monetary Policy recently set up within the RBI are mechanisms without teeth.

As Dr Anand Chandavarkar puts it: "The case for an independent RBI derives from the doctrine of separation of powers both to close India's democratic deficit and to insulate monetary policy from politics. Independence implies accountability, transparency and the creation of an executive (not advisory) monetary policy committee; revamping its inflated and overly hierarchical organisation; and divestiture of supervisory and quasi-fiscal functions."

Impressive record

There has not so far been any sleep been lost over these issues, nor had they intruded themselves into public consciousness, because in respect of all the vital indicators — inflation, prices, investment climate, balance of payments — of an economy on an ascending trajectory, the RBI, in close concert with the government, has continued to maintain an impressive record.

Except on very rare occasions in the distant past, the relations between the Governors of the RBI, and his colleagues on the one hand and on the other, the Finance Minister and his aides had almost invariably contributed to the forging of mutually supportive approaches.

Of considerable help in hammering out a consensus has been the high calibre, public-spiritedness and mastery of the complexities and intricacies of the economy of the main actors on both sides. The easy rapport between the two has enabled the Bank to diversify and expand its role without the need of any amendments to the RBI Act. There is no empirical evidence to suggest that this has told on its authority, credibility or effectiveness.

Even so, with the rise in the stature of India as a global economic player and its financial stakes assuming mammoth and complex proportions, it will be wrong to leave things to happenstance and individual equations.

The present Governor, Dr Y. V. Reddy, himself has argued the case for putting on a sound footing the scope and functions of the RBI as follows: "With the emergence of powerful economic interests in the form of multinationals or dominant domestic corporates and their large stakes in capital markets, in the larger context of powerful influences outside of the executive wing of Government, it may be necessary to ensure independence of central bank operations... There is (also) need to recognise the criticality of financial sector stability, especially of financial markets for which the RBI is assuming increasing responsibility...the emerging issues warrant a broader view of exercise of independence from several sources to meet emerging challenges like financial sector and markets stability while enlarging the concept of accountability through greater recourse to transparency."

All one can say is: Amen!

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