The autonomy of the Reserve Bank of India has been more of a fiction than a reality. The RBI was born on the All Fools Day in 1935 & its autonomy, for most of its history, has been a joke.
The issue of RBI’s autonomy had been in news about some months ago when the government used the Section 7 of the RBI Act for the first time in its history. For the uninitiated, Section 7 of the RBI Act gives the Government of India powers to issue directives to the RBI to carry out certain policies in the public interest. This undermines the autonomy of the RBI as the veto power is always with the government. It had been reported that section 7 had been used to issue certain directives to RBI regarding several issues of contentions like a separate regulator for payment systems, a liquidity crunch in NBFCs, transfer of RBI profits to government coffers & RBI’s PCA framework.
In 1956, T.T. Krishnamachari was India’s Finance Minister & who, in the words of T.C.A. Srinivas Raghavan, “thought that he knew everything but also that no one else knew anything.” Then, the governor of RBI was Sir Benegal Rama Rau. He complained thrice to the Prime Minister about TTK’s ‘rudeness’, ‘rude language’ & ‘rude behavior’.
Once Krishnamachari announced the monetary policy in the presence of the RBI governor, which was very different from what the RBI was going to announce.
Who needs section 7 when the finance minister could practically decide the monetary policy? According to B.K. Nehru, “TT. Krishnamachari let fly in no uncertain terms and in the loudest of voices that RBI was a ‘department’ or ‘section’ of the finance ministry.”
Prime Minister Jawaharlal Nehru too sided with the finance minister & wrote to Rama Rau that the RBI was ‘obviously a part of activities of the government and has to be kept in line’. When Rama Rau threatened to resign, Nehru said, “If you wish, you can send your formal resignation to the Finance Ministry”. Talk about autonomy. The entire thing sounds funnier when I tell you that just a little earlier, Nehru had written to Vaikunth Lal Mehta, the cooperative leader that the RBI had to have its autonomy.
After Rama Rau, Sir H.V.R. Iyengar took the position of the governor of RBI. This is what TCA Srinivas Raghavan writes about the subsequent terms in his book “Dialogue of the Deaf: The Government & the RBI”.
Under him and his successors, the RBI didn’t make any fuss about deficit financing or, indeed, about anything. Even when fourteen banks were nationalized, virtually overnight, by Indira Gandhi in 1969 the RBI merely sighed and accepted that the new department of banking would be the real boss. It has its differences of opinion which were expressed in long and lugubriously polite letters. But in the end, it did what it was told— just as it has always done since the time that Osborne Smith was sacked.
Sir Osborne Smith was the first Governor of the RBI & he was sacked for his disagreements with the Secretary of State in London. In 1936, he wrote in a letter that he was ‘sick to death’ of the government’s attempt to dominate the RBI. In the second half of the 1950s, RBI was asked to simply print notes to make up for the difference between the government’s revenue and expenditure. This deficit financing would give rise to inflation for which the RBI was responsible but It was left with no choices in this matter. B.K. Nehru would just phone RBI governor and order him to issue a certain amount of ad hoc treasury bills. In years to come, in spite of a dominant finance ministry, the RBI performed exceptionally well.
Unlike the independence of Judiciary, the autonomy of RBI isn’t something written down in our Constitution or the Law. The RBI Act itself gives powers to the government to issue directives to RBI under Section 7. The wide autonomy given to RBI by the Finance Ministry is a recent phenomenon. D. Subbarao started acting independently maybe from 2011. Raghuram Rajan got a fair amount of autonomy. And for Urjit Patel, we were back to square one.
Section 7 wasn’t invoked in RBI’s history because there was no need to do that. Governors implicitly accepted that RBI was created by a law passed by the parliament & they are only as autonomous as the government wants them to be. The Deputy Governor Viral Acharya in a speech warned that:
Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite the economic fire, and come to rue the day they undermined an important regulatory institution.
Those are some powerful words. It isn’t a surprise that the Government & RBI has disagreements. It is sad that they let the spat go public. The RBI didn’t want to play the part of a “wife in a Hindu joint family” anymore. And it was putting it out in the open that the government cannot infringe its autonomy.
Kadyalwar Sunil Abhinav