Just when questions were beginning to be asked whether the Reserve Bank of India (RBI) was being taken for granted by an assertive Union finance ministry — a question raised by North Block’s ordinance last month creating a “joint committee” of heads of regulatory institutions in the financial sector chaired by the Union finance minister — the central bank has acted to show that it has a mind of its own. Even as some policy-makers in Delhi were asserting that the back of the inflationary dragon had finally been broken and that there was no real need for a further hike in policy rates, the central bank stepped in to once again dampen inflationary expectations by raising the repo and reverse repo rates by 25 basis points each. Thought it should have, at the same time, reduced the margin between the two rates. The RBI action should reassure markets and signal that it remains focused on inflation and has not changed its basic view, repeatedly articulated, that the rate of inflation should be brought down to an average of around 5 per cent. For the record, of course, the Union finance ministry has backed the RBI decision. It would do well not to confuse markets by taking steps that some interpret as an attempt to devalue the central bank. The macroeconomic authorities in New Delhi should know that this is not in the interests of policy stability and predictability nor is it in their own interests, since there should be no confusion in any market participant’s mind that reversing the recent trend in inflation is the government’s most important policy priority for now. This becomes an even more important priority at this time when there seems to be some uncertainty regarding the prospects for the monsoon this year.
RBI has taken another, unrelated, step to reiterate its authority, and this relates to the proposed cap on salary hikes by private banks. While private banks require a measure of freedom in fixing salaries, to enable them to compete for good talent in a highly competitive and increasingly globalised market, the central bank’s advisory that such salary hikes should be within justifiable limits, especially at a time when the health of the banking and financial sector is under some pressure, is warranted. The central bank has made the additional point that bank salaries should be linked to risks and responsibilities of officials concerned. This too is fair. The bureaucratic system of uniform salary grades cannot be applied blindly to public sector enterprises, especially banks, which operate in a highly competitive environment. Keeping a close eye on bank compensations, including those offered by foreign banks, has become particularly relevant in the context of the moral hazard problem experienced in the recent trans-Atlantic financial crisis. The RBI’s view that a deterioration in the financial performance of banks should lead to a contraction in the “variable” remuneration offered, as opposed to some basic fixed pay, is well taken.
Taken together, these two announcements reveal a willingness on the part of RBI to take somewhat unpopular decisions, based on sound principles of prudent banking. An element of tension between the compulsions of North Block and those of Mint House is both unavoidable and advisable. Such tension need not always be viewed as a turf war. Rather, it must be seen as a manifestation of the willingness of autonomous institutions to take an independent view, even if in the final analysis it is the sovereign that prevails.