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A closer look at what we know transpired suggests that, in fact, the government won a victory.

Many of us will have breathed a sigh of relief as, after a marathon eight-hour meeting on Monday, it looked like India’s government and its central bank had finally made peace with each other after weeks of very public sniping. Reports after the meeting stressed that the tone had been “conciliatory.” (The Reserve Bank of India’s own readout of the meeting was terse and uninformative.)

Yet relief may be premature. A closer look at what we know transpired suggests that, in fact, the government won a victory. And the loser wasn’t just the Reserve Bank, but India’s institutional stability.

In India as elsewhere, when you want to postpone a difficult decision, you set up a committee. That’s precisely what the RBI and the government have agreed to do on the vexed question of how to handle the central bank’s reserves. The RBI, sitting on several trillion rupees of revalued gold and foreign exchange (thanks to the rupee’s sustained depreciation) thinks it’s holding the right amount to deal with the stresses that might emerge from a strained banking sector and a fragile current account balance. The government, meanwhile, wants cash. Nothing surprising there: Governments always want cash, though few have been as open as India’s about wanting to raid the central bank’s reserves for current spending.

The RBI’s board, which contains several government nominees, agreed to set up a committee to examine the bank’s reserves, one whose membership would be “jointly determined” by the finance minister and the RBI governor. This isn’t the worst-case scenario; that would have involved the government invoking a never-before-used clause of the law governing the RBI and forcing the transfer of reserves, probably prompting Governor Urjit Patel’s resignation.

But it isn’t good news either. The central bank’s position prior to the board meeting was clear: Deputy Governor Viral Acharya had, in a speech, warned against governments that meddle with central banks’ reserve requirements. Now, for the first time, the RBI has been forced to acknowledge that the government has a say in what it does with its reserves. The bank has had to back down, not the government.

That the fight between New Delhi’s bureaucrats and Mumbai’s technocrats hasn’t ended is clear from the fact that discussion on two other contentious issues has been quite obviously shelved till the RBI’s next board meeting in December. The first is disagreement about the amount of liquidity that the central bank should infuse into the system; the second is whether supervisory committees should be set up to oversee the RBI’s decision-making.

Both would also count as unwarranted intrusions into the domain of monetary policy. The RBI should certainly be held accountable — but not by some sort of appellate committee. The RBI governor can and should be summoned more often by Parliament to explain his actions publicly. Legislators have every right to question the RBI; the government shouldn’t assume the power to overrule it.

Within India, opinions on how this should play out are divided. Naturally, the equity markets would be quite happy with a less hawkish RBI, as more liquidity would extend the markets’ bull run beyond what the fundamentals would suggest. Indian shares are expensive by historical standards: The price-to-earnings ratio is around 23, and the growth rate of earnings for the blue-chip companies in India’s Sensex has in fact been negative in real terms over the past decade.

Many others are concerned that the RBI has consistently been more hawkish about inflation than the facts on the ground seem to warrant. Certainly, the RBI needs to be more transparent about its models for inflation. I myself have argued that the choice of consumer price inflation as a target means that monetary policy could get locked into a contractionary spiral.

On the other hand, one of the great achievements of successive Indian governments over the past couple of decades has been to increase the RBI’s institutional independence — capped by the current government’s laudable decision to allow an independent committee to set monetary policy, with a clear inflation target. Forcing the RBI to toe the government’s line on liquidity, reserves or banking supervision would reverse that trend and create an institutional vacuum that India simply cannot afford.

This is not the end of the war, or even of this battle; it’s merely a cease-fire. As long as the government is convinced it has the RBI playing defense, it will keep pushing. I fear that many more nerve-wracking board meetings lie in India’s future. – Bloomberg

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