Coordination between RBI, Central Govt need of the hour

The preamble of the Reserve Bank of India Act 1934 says ‘Whereas it is expedient to constitute a Reserve Bank of India 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.’

This gives an impression that the Reserve Bank has complete grip on the economy and the financial system where the Central Government, State governments, various markets, financial and other institutions and varieties of instruments and people interact and carry out transactions involving transformation of information and high technology. But, it has its own limitations and unless and until the Central Government gives full support and functional autonomy in letter and spirit, implementation of the preamble is practically rendered difficult.

Dominating influence

Further, the Reserve Bank alone cannot bring in the desired impact on the economy when the Central Government, which owns and controls the Reserve Bank by virtue of its owning the entire capital and having the powers to appoint its own well chosen officials on the Board of the Reserve Bank as Directors, has a dominating influence and can dictate its own terms and conditions not necessarily through force but giving signals through indications and expectations conveyed directly or indirectly.

The Bank has no choice but to act. Developing the economy is basically the responsibility of the Government and the Reserve Bank being the central bank of the country having the monopoly of issue of currency note has a joint responsibility with the Government to ensure that the value of the medium of exchange is stable both domestically and internationally and money is available in adequate quantity to develop the economy. This, in economic parlance, is called monetary stability, which if maintained well brings economic growth, price stability and financial stability.

Ups and downs

The growth of the economy and stability of the rupee have seen several ups and downs but all along the Government and the Reserve Bank have maintained perfect understanding and cooperation in strengthening the economy though differences of opinion have cropped up off and on.

But, of late, seeing the present state of affairs in the economy, one is not sure whether the relationship between the Reserve Bank and the Government continues to be cordial and the policies pursued by them in containing the problems of the economy are in tune with the thinking of each other.

The Government set up a Financial Stability Development Council with the Finance Minister as Chairman to oversee the financial regulators and counsel them to ensure financial stability despite the Reserve Bank’s reservations against such an arrangement. Then, the Government appointed an additional Director (for the first time in the history of the Reserve Bank) on the Board of Directors again perhaps to ensure that Government’s thinking gets prevailed and RBI yields to the pressures of the Government.

Over and above that the Finance Minister and the Chief Economic Advisor of the Government makes announcements as to what they expect from RBI just before the Reserve Bank gets ready to decide its monetary policy so that the Bank acts to their line of thinking.

The Finance Ministry also gives directions to banks as to what they should do with interest rates and credit expansion etc; although the banking system is regulated by the Reserve Bank and giving policy directives particularly on aspects of credit is the exclusive prerogative and privilege of the Reserve Bank.

Effectiveness of fiscal policy

The success of monetary policy is fully dependent on the effectiveness of fiscal policy pursued by the Central Government. The fiscal deficit, the economy is facing (at 5.1 per cent 2011-12), has been due to the inadequacies of the fiscal policy to contain food, fuel and fertilizer subsidies.

Further, the Government has failed to develop infrastructure, particularly in generating power, among other things that the economy demands to boost growth, make taxation policies to attract investment both from domestic and international markets, remove the supply constraints by concentrating in the agricultural production, storage and transportation, etc.

The result is continued persistence of inflation (at 7.7 per cent in 2011-12) without responding favourably to monetary policies. The import and export policies have their own short comings. While oil imports which are inevitable continue to rise, the gold imports do not fall drastically despite measures initiated to contain the same.

The increase in the consumption of both oil and gold the demand for which is inelastic to prices has widened the trade deficit. With the fall in inflows of foreign exchange, particularly under FDI and FII categories, the current account deficit is widening and is in the range of 4.1 per cent. Corruption and black money add miseries and the ease of doing business has been fast disappearing.

These are the areas where the Reserve Bank’s monetary policy cannot be of any help. Monetary policy can be said to be effective only if Reserve Bank gets the operational freedom to frame policies in the best interests of the economy which again depends upon the soundness of fiscal and other policies of the Central Government.

It is time for the Central Government to introspect and come out with policies in consultation with the Reserve Bank which has established itself as a very efficient central bank getting recognition for maintaining sound monetary and financial stability without yielding to the temptations or pressures of both domestic and international economic scenario.

It is to the credit of the Central Government that it does consult and coordinate with the Reserve Bank to frame and implement its fiscal policies.

(The author is a consultant. Views are personal)

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