HE GIST of Editorial for UPSC Exams : 09 November 2018 (Independence and accountability: on RBI)

Independence and accountability: on RBI

Mains Paper 3: Economy
Prelims level: RBI
Mains level: Issues relating RBI autonomy and accountability


  •  The Reserve Bank of India (RBI) and the government give the impression that they are not on the same page even as far as an understanding of their roles is concerned.
  •  This may be seen in statements by them on websites, Twitter and in the old-fashioned mode of the public lecture given by the Finance Minister and a Deputy Governor of the RBI, respectively.
  •  The RBI suggests that its independence is being violated while the government rationalises its intervention in terms of its concern for the economy.

Defining autonomy

  •  The idea of central bank independence began to germinate some two decades ago.
  •  This was understood to mean a ‘functional’ independence.
  •  The bank would be unconstrained by the government in its functioning, which includes both the instruments it uses and how it uses them.
  •  However, its autonomy was not to extend to ‘goal’ independence.
  •  What the goals of the central bank should be were to be chosen by the government without reference to the bank.
  •  The main issue here was whether the bank should focus on inflation alone or also on the level of employment.
  •  Within a decade of this debate, it had been conceded that the focus would be exclusively on the former, and monetary policy came to be identified with ‘inflation targeting’.

Concluding two points

  •  First, the discourse was solely among interlocutors from Western democracies, ensuring the issues were those related to their economies.
  •  Second, even as the major central banks of the world shifted to inflation targeting, in yet another example of American exceptionalism, the U.S. did not revise the goals of the Federal Reserve.
  •  It was to continue focus on maximising employment while keeping prices stable, a sensible recognition of a possible trade-off between these goals.
  •  In India where for close to a quarter century political parties of all hues appear to suggest ‘what is good for America is the best for India’, this has been missed.
  •  In 2015 the RBI was by law, in line with a “modern monetary policy”, expected to target inflation. It was to remain the banking regulator though.

Stability of the economy

  •  There is reason to believe that some of the actions being sought to be imposed on the RBI today could jeopardise the stability of the economy.
  •  While acting as the lender of last resort can be stabilising, under no circumstances would it be advisable to lower prudential norms in the presence of stressed banks.
  •  The government’s concern for the health of the medium and small enterprises is well-founded.
  •  They were among the most affected sections following the demonetisation of 2016.
  •  The government wants to reach out to them, the right course would be to provide interest rate subvention, rather than to force the RBI to tweak its lending norms.
  •  There is a severe lack of judgment in loan melas promising online sanction in less than an hour.
  •  There is the suggestion in this of the political business cycle, a government trying to nudge the economy prior to an election.
  •  The resistance of the RBI top brass to this desperate action is understandable.

Enabling job creation

  •  There is a certain populism inherent in privileging inflation control to justify extraordinarily high interest rates.
  •  While it would be bad economics to tolerate high inflation, the absence of inflation by itself only benefits those in employment.
  •  It does not assure jobs to the unemployed. Thus a monetary policy that ignores the impact of its actions on unemployment is not credible.
  •  The government and the RBI have always been on the same page as far as inflation targeting is concerned.
  •  Inflation erodes the income of the poor conceals the possibility that in the implementation such a policy could hold back job creation by restricting investment.
  •  The rising current account deficit, the slow growth of employment and the disappointing performance of manufacturing.
  •  The sector most closely affected by high interest rates, should prompt us to review how monetary policy is conducted in India.
  •  In the past, the RBI had a ‘multiple indicators approach’ which paid attention to inflation, growth and the current account.

Way forward

  •  The RBI should be left alone by the government to decide on the right course of action. This derives not so much from a notion of central bank independence as it does from the point of view of a credible governance policy.
  •  The Government of India would have chosen the Governor, participated in the choice of his deputies and had a say in the appointment of even the independent members of the central board of the RBI.
  •  In addition, the board has representatives of the government on it.
  •  It should now be left to this body to decide on the precise corrective action for banks with high NPAs.
  •  The desirable state of liquidity and the prudential norms to be observed by banks.
  •  The RBI is the banking regulator after all, and for the government to attempt to direct it would constitute micro-management.

Online Coaching for UPSC PRE Exam

General Studies Pre. Cum Mains Study Materials

Prelims Questions:

Q.1) Which among the following sectors is/are covered under the Index of Industrial Production (IIP)?

1. Mining
2. Manufacturing
3. Electricity
Select the correct answer using the code given below.
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer: D

Mains Questions:
Q.1) Why autonomy and accountability is so important for RBI?