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Markets will remain closed on 19th & 20th October 2017.
We wish all our readers a very Happy Diwali!

Is Reserve Bank of India Sovereign?
Tue, 25 Apr Pre-Open

The Reserve Bank of India (RBI) has a crucial role in managing the Indian economy. It is responsible for monetary policy decisions (i.e. setting interest rates) and providing stability to the currency. While doing so, it controls inflation and regulates the financial sector. And this crucial role demands that the RBI and government operate independently of one another.

In other words, the RBI should in no way be influenced by the political motives of the government in power. However, this is easier said than done.

As per an article in The Livemint, the latest monetary policy report of the RBI published earlier this month began with a rather unusual chart.

The chart and the accompanying discussion highlighted the fact that the near-unanimity of decisions in the monetary policy committee (MPC) was not a uniquely Indian phenomenon. The report pointed out that the "recent experience of MPCs in the UK, Sweden, Brazil, Thailand, Czech Republic and Hungary suggests that rate decisions have been based on unanimity".

The turn of events in the last year have also raised numerous questions on the independence of RBI. First there was controversy about whether Raghuram Rajan would receive an extension for his tenure, which ended with Rajan announcing that he would not be seeking another term. Then Rajan's predecessor D. Subbarao came out with a book where he has listed details of his disagreements with the government over various issues, and how he had to pay a price for it.

The biggest of them all, however, was reserved for the end. With Narendra Modi government's note-ban decision, questions about RBI's independence and credibility seem to have become the running refrain.

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In addition to the public debate on the issue, even RBI's employee union wrote a letter to the governor expressing its concern over infringement on the central bank's autonomy.

Economists have long argued that interference by the government in the functioning of the central bank could lead to low interest rates and stoke the fires of inflation. Governments driven by electoral calculations could, for instance, favor lowering of interest rates just before elections to provide a short-term boost to growth even if it comes at the cost of long-term inflation. Thus, there is a risk that monetary policy would become volatile, and lose credibility and effectiveness.

Meanwhile, others have argued that the very idea of an independent inflation-targeting central bank was patronized and promoted by influential bankers to ensure "predictability" in monetary policy that would help them make money on their bond market bets.

Economists such as John Goodman and Adam Posen have long argued that banks are often the staunchest supporters of a low-inflation regime because their balance sheet structure render them particularly vulnerable to inflation.

While RBI has fared better in maintaining financial stability during the crisis years, its anti-inflation record has been mixed over the past decade.

This awkward situation can impede economic growth and investor confidence. It might even drive us into an era of easy money policies such as those of the western world.

As The Honest Truth states...

The tenure and direction of India's economy over the remaining term of this government's time in power is 3 years. The next scheduled general election is around May 2019. The Governor of the RBI will also have 3-year tenure till September 2019. Together, they can create - or destroy - the foundation for growth years into the future.

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