A subject that was never really important but became controversial recently is the issue of independence of the central bank. This brings up the question of what should ideally be the form of functioning of the central bank.
Central banks, all over, are owned by governments as they become the monetary arm of the government which ensures that ‘money’ performs the functions it is supposed to do. The fact that the government through one of its own arms owns the central banks does inherently imply a conflict of interest because the central bank has to finally be tuned to the owner. Counter-intuitively, if the central bank is not owned by the government, then who could possibly own the same? There cannot be any private party owning the currency as it affects both domestic and international payments. Thus, the ownership structure is unavoidable. This holds for all regulators, too, as the buck finally stops at the government. That said, how should the central bank function then? There are two parts to this question. The first is the physical structure where all appointments are based on a government scale, which means that the recruitment process follows the same as in any public sector organisation, as do the pay structures and movement along the echelon. Some positions are directly appointed by the government through a set process. The other aspect is the functioning of the organisation which, prima facie, looks professional in the Indian context. This is, however, the area where the present controversy over independence emanates and the organisation structure per se has not really been part of the debate. RBI performs five major functions that are critical from the point of view of the economy which go beyond printing currency. These are areas where the wisdom of being independent can be argued. The first is acting as the facilitator of government debt. Here, there is an ongoing discussion over the extent of RBI’s support to the government’s borrowing programme. There are references made by RBI to keep this deficit under control. The government, on its part, has a fiscal programme which goes along the FRBM guidelines. Therefore, there are two responsible entities with differing views. RBI has done away with the earlier custom of directly financing the deficit and all borrowings are through the market. In the earlier days, there was the concept of private placements wherein RBI took on the debt directly. Today, banks buy these securities. But, through the backdoor, the same is absorbed by RBI through OMO or daily/term repos. This happens everywhere—the QE programme is nothing but the same, or the buyback operations of the ECB where the central bank buys government paper in the secondary market instead. The effect is the same. Are central banks being pressurised here? The answer is no, because, first, it is the function of the central bank to handle debt and, second, as banks are holding more than the stipulated level of government paper, it does not really matter. When we juxtapose the liquidity requirements of Basel III, the SLR appears to be, in retrospect, a good concept. Second, RBI is in charge of regulation of the financial system. Therefore, when we speak of inclusive banking or having new banks or structures for NBFCs and MFIs, they are meant for the financial well-being of the economy. The regulatory moves are based on well-researched papers submitted by committees comprising a cross-section of regulators, government officials and players, besides academics, and is more a consultative process with comments being taken from the public. There is unlikely to be any difference of opinion between the government and RBI and, therefore, there is little scope for controversy. Third, the supervision function of RBI is based on professional expertise rather than discretion. Supervision of various aspects of the system ensures that all of them adhere to the principles laid down formally. Here too, there is perfect harmony between the government and RBI. It appears to be more of a joint venture to ensure that the integrity of the system is preserved. Fourth, monetary policy could probably be sole the bone of contention. The government would inherently like to have lower interest rates as it keeps its own debt servicing levels down. It may also like to have low interest rates to spur growth. However, the central bank works as a professional institution and has followed the path of an economist in this respect using its own research, studies, experience and judgement to take a call. Considering that there is a tradeoff between inflation and growth going by conventional theory, RBI has sought to draw the best point here. While the government has often commented on monetary policy being one-dimensional as it tends to look at inflation, just like how RBI has expressed its own wisdom on the fiscal deficit, the final call has been taken by Mint Street. And this is best borne out by the change of guard at RBI last year, where the stance of the institution did not change, which actually shows a combination of healthy debate and judicious action. In fact, governments, which are driven by political expediency, know very well that while it is polemical to talk of lowering of interest rates, inflation is more likely to lose elections than low growth. Fifth, RBI has to control the forex reserves and hence the currency. Here as well, both, the government and RBI, are on the same wavelength as a stable currency and accretion of forex reserves are high on priority as it makes economic sense for any country. The recent episode of crisis had both the entities in sync. So, is there really a conflict of interest or forced action? Indian experience does not really highlight any of these conflicts going beyond the rhetoric. The central bank has worked like a central bank and there is little reason to believe that this would be different under any political regime. This harmonious working has ensured that we have not been in a situation like that during the Asian crisis, or the Latin American countries, Turkey or Russia, where political interference in interest and exchange rates brought about catastrophic repercussions on their economies. Therefore, independence has not been a serious issue in our context and talking of it today is probably more hype given the changing political scenario.
Central banks, all over, are owned by governments as they become the monetary arm of the government which ensures that ‘money’ performs the functions it is supposed to do. The fact that the government through one of its own arms owns the central banks does inherently imply a conflict of interest because the central bank has to finally be tuned to the owner. Counter-intuitively, if the central bank is not owned by the government, then who could possibly own the same? There cannot be any private party owning the currency as it affects both domestic and international payments. Thus, the ownership structure is unavoidable. This holds for all regulators, too, as the buck finally stops at the government. That said, how should the central bank function then? There are two parts to this question. The first is the physical structure where all appointments are based on a government scale, which means that the recruitment process follows the same as in any public sector organisation, as do the pay structures and movement along the echelon. Some positions are directly appointed by the government through a set process. The other aspect is the functioning of the organisation which, prima facie, looks professional in the Indian context. This is, however, the area where the present controversy over independence emanates and the organisation structure per se has not really been part of the debate. RBI performs five major functions that are critical from the point of view of the economy which go beyond printing currency. These are areas where the wisdom of being independent can be argued. The first is acting as the facilitator of government debt. Here, there is an ongoing discussion over the extent of RBI’s support to the government’s borrowing programme. There are references made by RBI to keep this deficit under control. The government, on its part, has a fiscal programme which goes along the FRBM guidelines. Therefore, there are two responsible entities with differing views. RBI has done away with the earlier custom of directly financing the deficit and all borrowings are through the market. In the earlier days, there was the concept of private placements wherein RBI took on the debt directly. Today, banks buy these securities. But, through the backdoor, the same is absorbed by RBI through OMO or daily/term repos. This happens everywhere—the QE programme is nothing but the same, or the buyback operations of the ECB where the central bank buys government paper in the secondary market instead. The effect is the same. Are central banks being pressurised here? The answer is no, because, first, it is the function of the central bank to handle debt and, second, as banks are holding more than the stipulated level of government paper, it does not really matter. When we juxtapose the liquidity requirements of Basel III, the SLR appears to be, in retrospect, a good concept. Second, RBI is in charge of regulation of the financial system. Therefore, when we speak of inclusive banking or having new banks or structures for NBFCs and MFIs, they are meant for the financial well-being of the economy. The regulatory moves are based on well-researched papers submitted by committees comprising a cross-section of regulators, government officials and players, besides academics, and is more a consultative process with comments being taken from the public. There is unlikely to be any difference of opinion between the government and RBI and, therefore, there is little scope for controversy. Third, the supervision function of RBI is based on professional expertise rather than discretion. Supervision of various aspects of the system ensures that all of them adhere to the principles laid down formally. Here too, there is perfect harmony between the government and RBI. It appears to be more of a joint venture to ensure that the integrity of the system is preserved. Fourth, monetary policy could probably be sole the bone of contention. The government would inherently like to have lower interest rates as it keeps its own debt servicing levels down. It may also like to have low interest rates to spur growth. However, the central bank works as a professional institution and has followed the path of an economist in this respect using its own research, studies, experience and judgement to take a call. Considering that there is a tradeoff between inflation and growth going by conventional theory, RBI has sought to draw the best point here. While the government has often commented on monetary policy being one-dimensional as it tends to look at inflation, just like how RBI has expressed its own wisdom on the fiscal deficit, the final call has been taken by Mint Street. And this is best borne out by the change of guard at RBI last year, where the stance of the institution did not change, which actually shows a combination of healthy debate and judicious action. In fact, governments, which are driven by political expediency, know very well that while it is polemical to talk of lowering of interest rates, inflation is more likely to lose elections than low growth. Fifth, RBI has to control the forex reserves and hence the currency. Here as well, both, the government and RBI, are on the same wavelength as a stable currency and accretion of forex reserves are high on priority as it makes economic sense for any country. The recent episode of crisis had both the entities in sync. So, is there really a conflict of interest or forced action? Indian experience does not really highlight any of these conflicts going beyond the rhetoric. The central bank has worked like a central bank and there is little reason to believe that this would be different under any political regime. This harmonious working has ensured that we have not been in a situation like that during the Asian crisis, or the Latin American countries, Turkey or Russia, where political interference in interest and exchange rates brought about catastrophic repercussions on their economies. Therefore, independence has not been a serious issue in our context and talking of it today is probably more hype given the changing political scenario.
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