Can govt direct central bank on policy and regulations? Yes, says RBI Act

Section 7 of the RBI Act empowers the Centre to do so

The Allahabad High Court on Monday asked the central government to hold consultations with the Reserve Bank of India (RBI), under Section 7 of the RBI Act 1934, on the way forward for stressed power assets in the next 15 days.

Can the government issue directions to the RBI on regulatory and policy matters? The answer’s yes. However, to date, the government has never issued directions to the RBI on its regulatory and policy affairs. A similar provision is present in most statutes that deal with the regulators, such as the Insurance Regulatory and Development Authority of India and the Telecom Regulatory Authority of India, according to a Mumbai-based lawyer.

During the Allahabad court’s hearing, the Independent Power Producers Association of India argued there is “every possibility” that the central government issue directions to the RBI to give relief to the power sector. However, the RBI’s counsel submitted that the question of the central government issuing directions “does not arise” at this stage and should have been done earlier.

According to Section 7 of the RBI Act, the central government may issue directions to the RBI as it may “consider necessary in public interest” after consultation with the RBI governor.

“The central government, however, is not expected to issue any directions, as contemplated under Section 7(1), indiscriminately or randomly. Such directions are possible when there exist sufficient material in support,” the court said in its observation, adding, “I, prima facie, find there exists material which deserves to be taken into consideration. The question, whether a breathing time deserves to be granted in the larger public interest and to achieve vision of power to all, needs to be answered by the central government.”

The government had asked for an additional 180 days to resolve the stressed power assets that have a total capacity of 12,000 megawatt. The court observed it would be appropriate for the “central government to step in” and decide if it wants to issue directions to the RBI, according to Section 7 of the RBI Act.

The court said that the Union government “remained unequivocal and ambivalent on whether it was even considering the exercise of these statutory powers.” “However, since the stated stand of the Union (government) before us has been in favour of extension of the 180-day period, perhaps the Union must therefore, be called upon to render serious thought on this aspect,” the court order stated.

Section 7 deals with ‘management’ of the RBI. Since the clause was never invoked in the past, there were various ways to interpret it. For instance, a senior government official on Monday maintained that the provision only relates to the management of the central bank and the central government may not be empowered to issue directions to the RBI on policy-related matters.

However, the Centre, had told the Supreme Court during a hearing on demonetisation of old currency notes of Rs 500 and Rs 1,000 in January 2016, that it has the powers to issue directions to the RBI, citing Section 7 of the RBI Act.

“The central government has the power to control the management of the RBI and the RBI may function, according to the directions given by the central government necessary for fulfilment of its objectives,” the central government’s counter-affidavit had said.

Experts were of the opinion that the RBI Act empowers the central government to issue directions to the central bank, even on regulatory issues, but the clause has never been invoked so far. “The government can direct the management of the RBI to sidestep the February 12 circular. This clause has never been used in the past and it will not set a good precedence. If they want to dilute the February 12 circular, the government can do so. They have a weapon in hand,” said Radhika Pandey, economist at the National Institute of Public Finance and Policy.

In a report released in January this year, the International Monetary Fund had said that the “RBI Act contains provisions that undermine its independence from the government” citing Section 7 of the RBI Act as an example. “While these provisions have not been used in practice, they remain available to the central government to use at its discretion in the event that it disagrees with the central bank regarding supervisory priorities or judgments,” the IMF’s report on India’s financial sector assessment said.

Going back in history, the RBI had itself drafted a provision combining the provisions of the Bank of England Act, 1946, and Commonwealth Bank of Australia, 1945, on the central government’s powers to issue directions to the central bank. It had, however, suggested that the Act makes it clear “when government decided to act against the advice of the (RBI) governor, they took the responsibility for the action they wished to force on the (Reserve) Bank,” according to the Volume I of the History of the Reserve Bank of India (1935-1951).

However, the government was not in favour of this provision and the clause was re-drafted accordingly. Though the RBI had sought for a more elaborate provision requiring the government to ‘accept responsibility’ for the action resulting from its directions, the Section 7 of the RBI Act was amended in 1949 to empower the central government to issue directions to the central bank in public interest.