EDEN IAS CURRENT AFFAIRS – GOVERNMENT vs. RBI

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EDEN IAS CURRENT AFFAIRS – GOVERNMENT vs. RBI

Introduction

The public fight between the Reserve Bank of India and the government is the latest instance of an unprecedented crisis in key institutions of the country. Just this year, four sitting Supreme Court judges held a press conference to air their concerns about case allocations; the top two officials of the Central Bureau of Investigation have been sent on leave following an internal fight and allegations and counter-allegations of corruption. Meanwhile, the government has initiated consultations under Section 7 of the RBI Act, which allows it to direct the Central bank in “public interest”.

The government has written to the RBI hinting it may invoke Section 7 of the Reserve Bank of India Act 1934 – a provision that has never been used since the inception of the law – to issue directions on relaxing prompt corrective action (PCA) norms, liquidity to non-banking financial companies (NBFCs), among others.

 

What does Section 7 of the RBI Act say?

Section 7 of the Reserve Bank of India Act

Section 7(1) of the RBI Act says: “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.” Section 7(2) gives the government powers to entrust the running of the RBI to its board of directors.

 

 

According to it, the Central government may issue directions to the RBI as it may “consider necessary in public interest” after consultation with the RBI Governor. Section 7 deals with ‘management’ of RBI.

This provision took centre stage earlier this year when the Allahabad High Court was hearing a petition from power companies who challenged stringent non-performing assets (NPA) norms notified by the RBI in February, also popularly known as the February 12 circular.

 

What happened during the Allahabad High Court hearing?

The court had asked the central government to hold consultations with the RBI, under Section 7 of the RBI Act 1934, on the way forward for stressed power assets within 15 days. But the government had decided against using this provision at that time.

Can the Government Issue directions to the RBI on regulatory and policy matters? The answer is yes, as was noted by the Allahabad High Court. However, till date, the government has never issued directions to the RBI on its regulatory and policy affairs.

“The Central Government, however, is not expected to issue any directions, as contemplated under Section 7(1), indiscriminately or randomly. Such directions are possible when there exists sufficient material in support,” the high court had observed in its order dated August 28.

The counsel representing RBI had said that Section 7 of the RBI Act “embodies and puts in place a forum for resolution of all questions and is in one sense the repository mechanism for dealing with issues which constitute a “conflict zone”.” He argued that the fact that the government has not invoked this provision so far means there is no conflict and the government agrees with the RBI’s tightening of the NPA norms. During the hearing, the government had remained silent on whether it wants to invoke Section 7 of the RBI Act to issue directions to the regulator or not.

A similar provision is present in most statutes that deal with the regulators, such as Insurance Regulatory and Development Authority and Telecom Regulatory Authority of India, according to a Mumbai-based lawyer.

The court observed that if the RBI and the government are at variance on any policy or regulatory issue, the latter should “consider whether the circumstances warrant the initiative of the consultation process” under Section 7 of the RBI Act.

 

Joseph Kuruvilla Vellukunnel vs. Reserve Bank view reiterated

The High Court also mentioned observations made by the Supreme Court in the Joseph Kuruvilla Vellukunnel vs. Reserve Bank case emphasising that “the Reserve Bank, apart from it being a reasonable body, is answerable to the Central Government, and the public opinion is certainly strong and vocal enough for it to heed. If the Reserve Bank were to act mala fide, the Central Government and in the last resort, the Courts, will be there to intervene.”

 

 

The High Court said that Section 7 of the RBI Act was put on the statute book in a bid to “arrive at a harmonious conclusion and evolve a consensual position.”

 

Various interpretation and issues

Since the clause was never invoked in the past, there were various ways to interpret it. For instance, a senior government official maintained that the provision only relates to the management of the central bank and the central government may not be empowered to issue directions to the RBI on policy-related matters.

Earlier, the finance ministry had not in favour of invoking Section 7 of the RBI Act to issue directions to the regulator for relaxing its February 12 circular. According to documents reviewed by Business Standard, the finance ministry had noted that the powers have never been used in the past, relates to the management of RBI, may lead to litigation, has a likelihood of “severe resistance” and such directions will need “strong legal footing.”

However, the Centre had told the Supreme Court during a hearing on demonetisation of old currency notes of Rs 500 and Rs 1,000 in January 2016, that it has the powers to issue directions to the RBI, citing Section 7 of the RBI Act.

“The central government has the power to control the management of the RBI and the RBI may function as per the directions given by the central government necessary for the fulfillment of its objectives,” the central government’s counter-affidavit had said.

In a report released in January this year, the International Monetary Fund had said that the “RBI Act contains provisions that undermine its independence from the government” citing Section 7 of the RBI Act as an example. “While these provisions have not been used in practice, they remain available to the central government to use at its discretion in the event that it disagrees with the central bank regarding supervisory priorities or judgements,” the IMF’s report on India’s financial sector assessment said.

 

History of the provision

Going back in history, the RBI had itself drafted a provision combining the provisions of the Bank of England Act, 1946 and Commonwealth Bank of Australia, 1945, on the central government’s powers to issue directions to the central bank. It had, however, suggested that the Act makes it clear “when government decided to act against the advice of the (RBI) Governor, they took the responsibility for the action they wished to force on the (Reserve) Bank,” according to the Volume I of the History of the Reserve Bank of India (1935-1951).

However, the government at that time was not in favour of this provision and the clause was re-drafted accordingly. Though the Reserve Bank of India had sought for a more elaborate provision requiring the government to ‘accept responsibility’ for the action resulting from its directions, the Section 7 of the RBI Act was amended in 1949 to empower the central government to issue directions to the central bank in public interest.

 

Six critical areas of conflict

  • Cash grab: The government has made repeated calls for the Reserve Bank to hand over more money from the RBI’s reserves to help fund its fiscal deficit. The RBI currently hands over its profits earned from various activities in the form of a dividend. But the government also wants to tap a share of the RBI’s Rs 3.6 lakh crore ($48.73 billion) of capital reserves. The RBI has consistently pushed back against the demand.
  • Out of the shadows: The government wants the RBI to provide more liquidity to the shadow banking sector, which has been hurt by the defaults of major financing company, Infrastructure Leasing & Financial Services (IL&FS). Those defaults triggered sell-off in bonds and stocks of non-banking financial companies. The government has been asking the RBI for a dedicated liquidity window for these lenders similar to one allowed during the 2008-2009 global financial crisis.
  • Just relax: The government has also been urging the RBI to relax its lending restrictions on 11 state-run banks. The curbs were imposed because the banks had a low capital base and major bad debt problems. The 11 are barred from lending unless they reduce their bad debt levels, improve their capital ratios and become profitable. The government says the restrictions have gone too far and have reduced the availability of loans for small- and medium sized businesses.
  • Encroaching: The RBI is also irked by the government’s efforts to trim the central bank’s regulatory powers by proposing to set up an independent payments regulator. Currently the RBI regulates all payments and settlements in the economy. The government says it wants a separate payment regulator which will be able to adapt to rapid changes in technology.
  • Board influence: The government appointed S Gurumurthy, a prominent BJP supporter and an affiliate of the Rashtriya Swayamsevak Sangh (RSS), to the RBI board earlier this year along with Satish Marathe, a former banker with ties to the RSS. Such political appointments have been unusual in the past as the RBI board’s external members have mostly been economists and industrialists. Traditionally, the RBI’s board has approved decisions related to internal functions of the central bank and it has not interfered in its supervisory and monetary policy functions.
  • Keeping mum: Senior government officials, as well as BJP and RSS officials, are angry that the RBI decided to go public over the quarrels. Acharya made it clear he had been asked to address the independence question by Patel and in a show of unity the three other deputy governors attended his speech. In its statement concerning autonomy, the government stressed that it will keep discussions confidential.

 

Conclusion

The difference of opinion between the government and the central bank is neither new nor unique to India. However, it is worth reiterating that it is necessary for the government to respect the operational autonomy of the central bank. Undermining the ability of RBI to take decisions will affect market confidence and end up complicating the policy environment. The government has done well by taking the first step towards defusing tension. It should now build on it and avoid unnecessary conflict with the central bank. The ball was always in the government’s court.

 

 

 

 

 

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