There aren’t many occasions in history where friction between the RBI and the government has not made headlines.

Former Reserve Bank of India (RBI) governor Bimal Jalan, in an interview given to the Mint newspaper seems to have offered an advice to current governor, Urjit Patel who is busy fighting a turf war with the Narendra Modi government--Quit the job if you can’t make peace with the central government. “Ultimately, your duty is to perform and do what you have promised to do in people’s interest. Now, supposing you feel I should give much more weightage to growth or inflation and the government is not listening and you are very particular about it. Then you should move and somebody else should come. What’s the harm?,” said Jalan, who has served top posts both in the government and the RBI. Jalan was RBI governor for two terms preceding Y V Reddy and has guided the economy during some of the tough years of the currency crisis.

Theoretically, what Jalan suggested to Patel-- ‘Quit if you can’t make peace with boss’-- sounds like a daring act. If the RBI governor is not in a position to dispense his constitutionally entrusted responsibility, it hardly makes sense for him continue to hold the office. But, such a solution to settle the turf war between the RBI and the government could prove to be disastrous for the Indian economy; it can unsettle the already disarrayed financial markets in a big way and no amount of state intervention may suffice to bring sanity back to trading terminals. The catchword here is ‘irreconcilable’ differences. Have things actually reached such a tipping point yet?

Points of contention

Look at the key areas of contention between the RBI and the government--liquidity management, payment/ debt management regulation, government influence on the RBI central board and pressure tactics to negotiate rate cuts to safeguard their side of growth-inflation trade off. These aren’t really new or irreconcilable issues, if one takes a closer look. The only fresh issue during the Patel era is the way NPA-clean up is being carried out in the banking sector. The so-called Prompt Corrective Action (PCA) implemented in nearly a dozen state-run banks by the RBI, have not gone down well with the government. But, the NPA-clean up itself is a programme jointly initiated by the RBI, under former governor Raghuram Rajan, and the Modi government and continued by Patel.This isn’t RBI’s baby alone in that sense.

Also, a question arises, what changed suddenly for the RBI to go on a warpath with the government? It is the same RBI which happily remained a silent spectator during the demonetisation episode, which was a clear case of turf violation by the government with the RBI, the actual authority of currency management in India. But the RBI then chose to silently approve the/ whole scheme and drew a lot of flak for implementation faults.

There aren’t many occasions in history where friction between the central bank and the government has not made headlines. In fact, the central banks’ powers have been challenged not just by the NDA, but also by the previous UPA government on issues of debt management, banking regulation and monetary policy. Former union finance minister, P Chidambaram had once famously said the government will “walk alone” if need be to support growth when he didn’t get the desired outcome from the RBI monetary policy rate actions at that juncture.

Inflation warrior

The RBI’s primary mandate is guarding price stability in the economy and not supporting growth. While this has always been the case, post-he MPC (monetary policy committee) formation, it is bound by a law to target inflation. Technically, guarding growth or supporting value of currency is not RBI’s direct concern as much as targeting inflation. Also, central bank’s view on major policy issues is keeping view of the long-term implications while politically guided governments tend to have a short-term view. It is inevitable in large democracies that central bank and government of the day to have frictions. It is in this context one has to see the ongoing RBI-government debate.

Now, is RBI really an autonomous body? It is not. The RBI Act doesn’t give the central bank absolute autonomy. According to the RBI Act, 1934, the central bank is answerable to the government. Section 7 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.” It is this clause that dominated the headlines last week with respect to the RBI vs government turf war.

At some point, the dialogue process between the RBI and government suffered big leading to a public outburst by deputy governor Viral Acharya.

Tipping point

As this writer pointed out in an earlier column, it is the duty of a government in a well-functioning democracy to ensure that the central bank is operating with functional autonomy. The simple reason being the central bank, not the government, is the guardian of the economy from the perspective of a foreign investor. If the message that goes abroad from the ongoing turf war is that the government is undermining the autonomy of the central bank, it can prove to be detrimental to the economy. But, at the same time, the central bank too has a duty to engage with the government constructively given the fact that absolute autonomy isn’t a given for the central bank in India under the constitutional setup. The government took the right step by issuing a statement last week to ease the tension with the RBI where it acknowledged the need for functional independence to the central bank.

It is time for the RBI to reciprocate in a constructive manner. If at all Urjit Patel resigns over differences with the government, it will be over hurt egos not on issues that do not have solutions. It will lead to chaos in the financial markets and frighten investors. The larger interest of the economy deserves more merit than the central bank and the government proving who is the boss in the battle of egos. Bimal Jalan’s ‘quit if you can’t make peace with the boss’ advice to Patel, if followed will be a bold act, but a disastrous recipe for financial markets.