Scroll Explainer: What you need to know about the Centre vs RBI battle

It has been a year of unprecedented institutional battles in India. From four sitting Supreme Court justices addressing the media in January, to the Central Bureau of Investigation raiding its own offices in October, 2018 has seen the government presiding over major struggles within institutions, with the Centre’s own behaviour being the cause of many of them. The revelation on Wednesday that the government was considering invoking the never-before-used Section 7 of the Reserve Bank of India Act – which permits the Centre to instruct the central bank – only added to the list of controversies that Prime Minister Narendra Modi has presided over just this year.

The Centre vs RBI battle, like many of the other institutional fights, revolves around some rather complex policy matters and legal provisions that are little understood. Here is an attempt to simplify some of that:

What is Section 7 of the RBI Act?

The operative portion of the provision is this: “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.” In other words, if the government wants to, it can give orders to the RBI.

Why is it so controversial?

The provision may seem innocuous, mirroring language that turns up in the Acts governing all the autonomous regulators. But the key point is, it has never been invoked. In all of independent India’s history, through economic crises and bitter battles between the government and Reserve Bank of India, the Centre has never chosen to use section 7.

No previous government has felt the need to invoke what would be the equivalent of ‘emergency powers’ over the central bank. And here is why this seems even more egregious right now: The Indian economy is not in recession. It is not crashing. There is no global crisis. The government claims that India is the fastest-growing major economy on earth. And Urjit Pael is a Modi-era appointee, not a governor installed by the previous government. If things are going so well, why would the government feel the need to invoke a never-before-used provision with the central bank?

How would it actually work?

Because it has never been invoked before, no one is quite sure. The only thing most seem to agree on is that, if the government does indeed try to use section 7 – and somehow bypass the Governor in the process – then Urjit Patel should resign. Sruthisagar Yamunan takes a look at the specifics here.

How did Centre-RBI relations get so bad?

In the first few months of Governor Urjit Patel’s tenure, he and the RBI board were actually accused of being too pliant in the face of government instructions. In particular, queries were raised about how the RBI went along with the government’s orders during demonetisation, and in the release of data about the note ban afterwards.

But over the last year or so, ties between the Centre and the central bank have steadily deteriorated.

• Interest rates: In June 2017, the Reserve Bank of India turned down a request from the government for a team of finance ministry officials to meet with the Monetary Policy Committee, which sets the central bank’s interest rates, ahead of a rate policy review. The government has frequently felt that the RBI overshoots its inflation estimates, and so the MPC has kept interest rates tighter than they ought to be, meaning borrowing money is expensive.
  
• February circular: In February 2018, the RBI put out a circular on classification of non-performing assets that required banks to refer any account with a loan of more than Rs 2000 crore to bankruptcy court if it is not resolved within 180 days of a default. The decision caused panic for many companies, in particular those in the power sector. Industry and government have tried to push for RBI to relax its regulations, and even went to the Allahabad High Court, which then suggested that the government could use section 7 to modify the order. As of now, though, the circular still holds.
  
• PNB-Nirav Modi scam: After the Rs 11,000 crore Punjab National Bank scam, involving jewellers Nirav Modi and Mehul Choksi, was revealed earlier this year, the government tried to point fingers at the central bank, with Finance Minister Arun Jaitley saying “in the Indian system, we politicians are accountable, the regulators are not.” Governor Urjit Patel responded in a speech to say that the RBI actually does not have enough control over public sector banks, where the government has more powers.
  
• Prompt Corrective Action norm: The government claims that it was kept in the dark about the RBI’s Prompt Corrective Action norms in April 2017 and its revised framework for banks to identify Non Performing Assets. The Finance Ministry has claimed that the central bank went ahead with this policy without fully keeping the government in the loop. Business Standard, however, reported that the government had broadly agreed to the new norms following discussions well before they were announced.
  
• Non-Banking Financial Companies: The unexpected default of IL&FS, a major Non-Banking Financial Company also led to some disagreement, with the finance ministry consistently pushing the RBI to make it easier for other NBFCs to get credit, since it is worried about a liquidity crisis. The central bank, however, insists that the IL&FS fallout has not spread enough for it to do this.
  
• Payments regulator: An inter-ministerial committee set up by the government recommended that India’s payments ecosystem should be regulated by a new institution, a payments regulatory board, rather than the RBI. This proposal led to a rare dissent note that was publicly circulated by the RBI, in which it argues that keeping banking and payment regulations with the same institution inspires public confidence.
  
• RBI board: The composition of the RBI board has been a point of contention, with some on the Right arguing that the central bank is too ‘Western’ in its thinking. The government removed banker Nachiket Mor from the board without any intimation, an unprecedented action from the government, which was welcomed by the Rashtriya Swayamsevak Sangh-affiliated Swadeshi Jagran Manch. The government also installed S Gurumurthy, convenor of the SJM, on the RBI board.
  
• RBI reserves: There have been suggestions that the government may once again ask the central bank to transfer a larger chunk of its surplus to the Centre than has already been announced, in the hopes that it can help bridge the ballooning fiscal deficit. In 2017, when asked for a larger transfer, the RBI said no.
  

Reports have indicated that the government brought up the use of Section 7 in the cases of a larger transfer of reserves, providing more liquidity to NBFCs and to ease the Prompt Corrective Action norms, as the Allahabad High Court suggested. Officially, though it is unclear in what matter section 7 was raised.

What have the RBI and the government said?

The RBI has not directly spoken about the matter, but the indications of a major rift were clear when Deputy Governor Viral Acharya gave a speech in which he said that eroding the independence of central banks would ignite “economic fire.” Read more about that speech here.

On Wednesday, the government did not deny bringing up Section 7 with the RBI. Instead it put out this statement:

The autonomy for the Central Bank, within the framework of the RBI Act, is an essential and accepted governance requirement. Governments in India have nurtured and respected this. Both the Government and the Central Bank, in their functioning, have to be guided by public interest and the requirements of the Indian economy. For the purpose, extensive consultations on several issues take place between the Government and the RBI from time to time. This is equally true of all other regulators. Government of India has never made public the subject matter of those consultations. Only the final decisions taken are communicated. The Government, through these consultations, places its assessment on issues and suggests possible solutions. The Government will continue to do so.

What happens next?

There were rumours that RBI Governor Urjit Patel would resign, but for now those have amounted to nought. Patel has called a meeting of the RBI board on November 19, which will undoubtedly cover much of the ground that has been contentious. The outcome of that meeting should offer some clarity, or lead to even more sparring.