The New Phase Of Reserve Bank-Finance Ministry Conflict

In media and India’s financial circle, speculation is mounting on the “deteriorating” relationship between the finance ministry and the Reserve Bank of India (RBI) and the “attack” on the central bank’s autonomy.

During the so-called demonetisation exercise in November-December 2016 when high-value currency notes worth 86% of money in circulation were withdrawn all of a sudden, the Indian central bank did everything it could do to support the government move. This annoyed many, including a couple of past governors of RBI, who found the central bank being subservient to the government.

The April policy statement in which RBI sounded pretty hawkish (after changing the monetary policy stance from accommodative to neutral in February) led to the first outburst by the government. Arvind Subramanian, chief economic adviser to the government of India, was vocal against the monetary policy committee (MPC) as well as the central bank for not cutting the policy rate despite considerable easing of inflation pressure.

The analysts’ community largely ignored that as yet another instance of the classic conflict between growth and inflation in Asia’s third largest economy. By tradition, the government pushes for rate cuts for short-term growth while the central bank’s primary mandate is curbing inflation and in the long run only low inflation could fuel sustainable economic growth.

The finance ministry summoning members of MPC for a meeting is the latest provocation for the speculation on the RBI-finance ministry relationship.

What exactly happened?

A not-so-senior bureaucrat of the finance ministry wrote to MPC members, inviting them for a meeting in Delhi just two days ahead of their meeting at RBI headquarters in Mumbai, ostensibly to put pressure on them for a rate cut. MPC has six members, including three from RBI—governor Urjit Patel, deputy governor Viral Acharya and Michael Patra, an executive director. The finance ministry wanted to have two separate meetings, one with MPC members from RBI and another, with the outsiders. All MPC members declined the request for the meeting.

Had they met the ministry officials ahead of the policy meeting, they would have ended up compromising the credibility of MPC. Even if they had chosen to only listen to the finance ministry officials and not acted on their “advice”, it would not have been easy to communicate to the market the stance of the monetary policy. Post such a meeting, had MPC decided to cut the rate, it would have been obvious that it did so under pressure from the government; and, had it not gone for a rate cut, the interpretation would have been that MPC is extra-hawkish.

The RBI Act was amended last year to provide for a statutory and institutionalized framework for MPC whose objective is to maintain price stability, “while keeping in mind the objective of growth”. The members of MPC are to be appointed by the government but it has no business to directly interfere in the functioning of MPC. Calling MPC members for a meeting in Delhi ahead of the policy is an open attack on it. The MPC is not even a year old (it was constituted in September 2016) and the June meeting was its fifth since inception. Such an attack on a fledgling MPC will considerably weaken it even if certain finance ministry officials do not care about their own credibility.

If the past meetings of MPC are anything to go by, it has started showing signs of maturity. While decisions at its first three meetings were built on consensus, in the April meeting, RBI’s Patra almost pitched for rate hike (it’s another matter that he misread the inflation trajectory) and professor Ravindra H. Dholakia in June was strongly in favour of a rate cut.

The June monetary policy statement (MPC deliberations are not in public domain as yet) makes it clear that the members of the committee do appreciate that the risks to inflation are lower now that what they were in April. The mid-year and the year-end projections for retail inflation have also been pared considerably; yet most members of the committee were against a rate cut as they wanted to be sure that in the medium-term retail inflation would stay within the 4% limit that the committee is targeting.

The government can always have a different view, but it could have been communicated to RBI in a different way. Typically, ahead of every monetary policy, the RBI governor always meets the finance minister in the North Block that houses the ministry. This had been the tradition till MPC was constituted. In fact, I always wondered why the governor would meet the finance minister carrying the policy document in a brief case and why they could not talk on phone. Instead of a bureaucrat writing letters to MPC and making this public within hours of writing it, the Prime Minister’s Office or the finance minister could have called the governor for an informal meeting on the state of affairs in the Indian economy ahead of the policy.

With the May retail inflation slowing to 2.17% and the likely fall of June inflation to below 1.9% (that’s the last inflation data that MPC will have on its table before its August meeting), it’s almost a given that there will be a quarter percentage point rate cut in August. The bond market has already priced in this cut.

So, why are finance ministry officials in such a hurry to push for a rate cut? Probably slowing economic growth since June 2016 has made them a worried lot but the rate cut alone cannot propel growth. At the current juncture, even if the loans are given free, there is hardly any taker for money for many other reasons. Besides, already saddled with bad loans, the banks are wary of giving loans for fear of accumulating more bad loans. RBI is addressing this issue on a war-footing and rightly so. Of course, a rate cut at this point will drive down the bond yield, leading to treasury profits of banks and helping them clean up their balance sheets. It will be recapitalization by stealth but will not fuel economic growth.

Also, any attack on MPC will not be liked by the foreign investors who are ready to pump in money in India, looking at its rock solid macro-economic and political stability. They are convinced that India is determined to slay inflation for good. Of course, there are many, including some foreign investors, who aren’t liking MPC delaying the rate cut but the delay is a far better option than having an impotent MPC.

This column first appeared in www.livemint.com

To read the writer’s earlier columns, please log onto www.bankerstrust.in

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo.