Govt and RBI have to respect each other's turf, says Raghuram Rajan

'The aim of the board is to be Rahul Dravid - sensible, thoughtful and not, with due respect, Navjot Sidhu', says Raghuram Rajan, former RBI governor

Former Reserve Bank of India (RBI) Governor Raghuram Rajan on Tuesday said the rift between the central bank and the government could be resolved if both sides respected each other’s intent and autonomy. 

“The RBI is something like a seat belt. As a driver, the driver being the government, it has the possibility of not putting on a seat belt, but of course if you do not put on your seat belt you get into an accident, and the accident can be quite severe,” he told CNBC TV18.

Rajan also defended the central bank’s call for greater autonomy from the government. “As far as possible, it is in the interest of the country that we respect the institutional autonomy of the Reserve Bank, as well as the traditions,” said Rajan, who was succeeded by current governor Urjit Patel in September 2016.

Rajan, who is finance professor at the Chicago Booth School of Business in the US, commended Viral Acharya, deputy governor, RBI, for warning of risks stemming from government meddling in central bank affairs. But he also said the RBI could inject liquidity to ease any cash crunch at financial institutions, indirectly supporting the government's call for a liquidity window for non-banking financial institutions (NBFCs). “If it's a liquidity problem, the central bank can flood the market with liquidity or give the liquidity to specific private entities that are healthy, and are willing to lend to these other entities that are in trouble,” said Rajan.

Historically, the government wants to focus on improving growth, and it does all it can within limits set by the RBI, which are based on financial stability. “So the government will push, will try and get the RBI to be more lenient,” he said, adding the central bank would examine them in close details and in reference to risks to financial stability. “We (RBI) have responsibility for financial stability, and therefore we have an authority to say no.” 

According to him, the relationship between the two has gone on for long and the fact that the RBI says no is not new. “The government can keep asking and say, please consider this, please consider that, but at some point, it says okay I respect your decision, you are the financial stability regulator and I back off,” he said. 

“Of course the RBI doesn’t say no out of petulance. It says it because it has examined the situation and believes that this take implies too much financial instability,” Rajan said. “I think that the relationship has gone on for long and the fact that the RBI says no is not new. The government can keep asking and say please consider this, please consider that but at some point, it says okay I respect your decision, you are the financial stability regulator and I back off.”

“Once you have appointed these deputy governors and governor, you have to listen to them because that is what you have appointed them for, they are your safety belt,” he said.

On the issue of the government citing Section 7 of the RBI Act that gave the government powers to issue directions to the RBI governor on issues of public interest, Rajan said it would be best if each side respected each other’s motivation and thoughts. On the role of the RBI board, he said its role historically had not been to take operational decisions, but focus on broader strategy as well as good governance. “So, they are there to ensure that the government’s money is well spent in the RBI, for example, the RBI doesn’t pay itself inordinate salaries and so on but also to serve as a sounding board, which is why we have people from different walks of society, very eminent people.”

“So, my sense is that the objective of the board is to protect the institution, not to serve others’ interest; it is to protect the health of the institution but also to provide wide, sensible advice. The aim of the board is to be Rahul Dravid — sensible, thoughtful and not, with due respect, Navjot Sidhu,” he said.

Tensions between the RBI and the government came to the fore last month after a scathing speech by Acharya, which focused on the dispute on issues ranging from lending curbs for banks under the prompt corrective action, more cash availability to NBFCs and on dipping into Rs 3.6 trillion of the central bank’s reserves. The speech roiled markets and prompted the government to issue a statement in support of the central bank’s autonomy. Many viewed Acharya’s comments as a sign that the RBI was pushing back hard against government pressure to relax its policies and reduce its powers ahead of a general election due by May.

A couple of days later, it emerged that the government had used a never-before-used provision of the law, Section 7, to seek consultation on issues, including the easing of non-performing asset norms so that banks could kick-start lending and support growth, and transferring more dividend to boost liquidity.