 "Finance Minister Arun Jaitley with RBI Governor Raghuram Rajan")
He hasn't yet talked about "walking alone" on the growth path as his predecessor did out of sheer exasperation, but Finance Minister Arun Jaitley has had to talk a great deal about the government's relationship with the Reserve Bank of India, or RBI, ever since taking charge in May last year. The last time he spoke about it was as recently as March 22, when he told reporters after addressing an RBI board meeting that the ministry and the central bank have been engaged in "free and frank" discussions and that there was no "disconnect".
Only a few took Jaitley's comments at face value. And there were good reasons for that disbelief. The first sign of difference between the government and RBI, led by its 32nd governor, Raghuram Rajan, came when the latter proposed appointment of a chief operations officer with deputy governor's rank. That proposal was shot down by the government when the previous finance secretary, Arvind Mayaram, was on the RBI board.
Things haven't improved much since then. From the day he joined RBI, Rajan wanted to initiate long pending reforms in the financial sector and quickly set up a few committees like the Nachiket Mor Committee on financial inclusion, Urjit Patel Committee on revisiting the monetary policy framework, and PJ Nayak Committee to review governance issues in bank boards.
Some of these committees had explicitly highlighted the need for the government to give up its control over public sector banks, which was also endorsed by the central bank. These committees said excessive control by the owner not only hampers governance in public sector banks but also acts as a hindrance to monetary policy transmission as public sector banks control 70 per cent of the market.
The government accepted the Urjit Patel Committee's recommendations on targeting inflation as the sole objective of RBI, but it is yet to agree with the proposal that a majority of the members of the monetary policy committee should be from RBI. Finance ministry's reservation is that it would be like giving all the powers of the committee to the governor, as the deputy governor and the executive director in charge of monetary policy, who will be the other two members of the proposed five-member committee, will not speak against their boss. This was the view of the previous government, and the present one shares the sentiment.
No wriggle room
So the government entered into an agreement with RBI to set the inflation target and said the monetary policy committee would be set up in due course of time, as this would require the lawmakers' approval. A joint statement was issued, two days after the recent Budget, saying that the target for January 2016 would be to bring inflation below 6 per cent, while the target for the next financial year (2016-17) and subsequent years would be 4 per cent with a variation of 2 per cent.
Clearly, the near-term emphasis was 6 per cent and not 4 per cent as the Urjit Patel Committee had suggested. With inflation trending below that mark for the last few months, RBI had no option but to cut the rate on March 4, two days after the agreement was signed. Another big source of tension was the Budget of 2015-16, which officially started the process of leaving the central bank with the task of only a monetary policy maker and banking regulator.
The process to clip the central bank's wings was started during the previous government's rule which had set up the Financial Sector Legislative Reform Commission, or FSLRC. The separation of the debt management office from RBI, shifting regulation of money market away from the central bank, et cetera have its origin in the FSLRC report which Rajan had once famously termed as 'somewhat schizophrenic'.
The separation of the debt management office, which was conceptualised long back, was on the pre-condition that the government's borrowing will be reduced. That has not happened; with borrowing staying high, year after year the country is running a high fiscal deficit. Now the 3 per cent fiscal deficit target - as set by the previous government - has been pushed by one more year to 2017-18.
While the conflict of interest argument that the central bank cannot be both the monetary policy authority as well as the manager of government debt has its own merits, observers say the same argument is also true if the government manages its own borrowing. There could be instances that even if inflation stays high, the government could want still lower yields to keep its cost under check. If that is the case, then the monetary policy - which is the sole responsibility of RBI, according to the new framework - becomes ineffective and the central bank will be held accountable for what is not in its hand, they say.
While proposing that the function of RBI as a depository is being shifted to a Public Debt Management Agency, or PDMA, the Finance Bill also says that PDMA can act as a depository or choose a third party as a depository - like a stock exchange.
Similarly, taking away money market operations from RBI, which includes interbank repo and issuance of commercial papers, could adversely impact monetary transmission which will affect the present role that is played by RBI.
The Budget has two other elements which are not in sync with the thinking on Mint Road. One was the setting up of an International Financial Centre - the first of its kind in the country that will pave the way for dealings and settlement in foreign currency - in Gujarat. Many top RBI officials were surprised that it is not being set up in Mumbai, the commercial capital of the country.
The second was the proposal to create a Micro Units Development Refinance Agency Bank. It is proposed that this bank will refinance microfinance institutions. The concern in RBI is that it can morph into the regulator for microfinance institutions, in line with the National Housing Bank, or NHB, which is the regulator for housing finance companies. RBI has in the past argued for the abolition of NHB on the grounds that it is both a regulator and refinancer, which can lead to a conflict of interest.
Clearly, the last word has not been heard in the tension between RBI and the finance ministry.
