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Autonomy of Reserve Bank of India

Reserve Bank of India is the apex monetary institution of the country and it
was started functioning in 1935 based on RBI Act 1934. RBI was nationalised in
1949 and became an independent body. RBI was established mainly with the
objectives of attaining price stability in the country, debt management and to control
the banking system within the country. RBI also has a monopoly power in the issue of
currencies in the country. It is the duty of the RBI to implement the monetary policy
of the country with an objective of regulating money supply and stabilising the price
level.

RBI is currently a self governing institute which fixes its targets and works
under its rules. It is free from external control of government. So far, Central
Government can only suggest RBI but RBI has the freedom to implement their
suggestions. But this doesn’t mean that RBI is fully free from government or
political pressure in its policy making. Many observed that the demonetisation of
high-denomination currency announced by the Prime Minister on 8th November 2016
was an encroachment into the autonomy and institutional integrity of the Reserve
Bank of India. But this was not the first incident, even decades before there were
clear signs of breaking the autonomy of RBI.

In March 1968, the RBI was forced to reduce the bank rate by one percentage
on recommendation of the then finance minister, Morarji Desai, to help the industrial
class. The prevailing macroeconomic environment did not justify this step, but the
then RBI governor, Lakshmi Kant Jha, meekly surrendered and the market was
stunned at this blatant political interference. The same Governmental interventions
were found in RBI’s policy making during the nationalisation of private sector
commercial banks during 1969 and during the emergency in mid 1970s. There were
numerous cases of interference by the political class in the RBI’s appointments and
administration and in its credit authorization policies to the benefit of large business
houses. Thereby, the RBI was reduced, briefly, to a pliant institution, subservient to
the elected gentry. Few years back the former Union Commerce Minister Nirmala
Sitharaman argued for a 200 basis points rate cut from the RBI to enable banks lend
cheaper money to micro, small and medium enterprises. In the same manner
Subramanian Swamy too had asked for sharper rate cuts to support growth.

Some provisions in RBI Act permit the Central Government to interfere in the
activities of the RBI. As per RBI Act, the Central Government may from time to time
give such directions to the Bank as it may, after consultation with the Governor of the
Bank, consider necessary in the public interest The reason behind this clause is so that
any major decisions are made by the government which is elected and hence
accountable to the people. Some Studies made by N. Nergiz Dincer and Barry
Eichengreen from TED University, Ankara, and University of California Berkeley
found that the RBI to be the least independent among 89 central banks they have
looked at in their study.

Arguments for and Against the Autonomy of RBI

Arguments for RBI’s Autonomy

1. Governments tend to make poor decisions about monetary policy. In particular


they tended to be influenced by short term political considerations.

2. Before an election, the temptation is for a government to cut interest rates,


making boom and bust economic cycles more likely. Therefore arguably, it is
better to take monetary policy out of government’s hands.

3. If government has a track record of allowing inflation, then inflation


expectations start to creep up making inflation more likely.

4. An independent Central Bank may have more credibility. If people have more
confidence in the Central Bank, this helps to reduce inflationary expectations.
In turn this makes inflation easier to keep low.

5. It is a sign of political maturity to leave such an important matter of public


pandering free from political control .
Arguments against RBI’s Autonomy

1. Economic policy set by unelected officials.

2. Concerns on wide impact of monetary policy, e.g. impact of low interest rates
on distribution of income between savers and borrowers.

3. Since Central Banks were made independent there has been a change in

economic climate. Inflation and booms are no longer major issue. Instead issue
is one of secular stagnation and prolonged liquidity trap.

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