Always a fine balance

The RBI-government tussle must prompt a debate on defining the RBI Governor’s position

Updated - December 04, 2021 11:54 pm IST

Published - November 02, 2018 12:15 am IST

KARNATAKA - BENGALURU - 02/01/2017 :  Large number of policemen posted outside Reserve Bank of India (RBI) on  Nrupathunga Road, in Bengaluru on January 02, 2017. After protests from the many people who had come to RBI for exchanging of banned old Rs 500 and Rs 1000 currency notes, and was turned away, by saying at the RBI had not received any communication from their head office to exchange old notes.   Photo: K. Murali Kumar.

KARNATAKA - BENGALURU - 02/01/2017 : Large number of policemen posted outside Reserve Bank of India (RBI) on Nrupathunga Road, in Bengaluru on January 02, 2017. After protests from the many people who had come to RBI for exchanging of banned old Rs 500 and Rs 1000 currency notes, and was turned away, by saying at the RBI had not received any communication from their head office to exchange old notes. Photo: K. Murali Kumar.

Yaga Venugopal Reddy, a former Governor of the Reserve Bank of India, (RBI) known as much for his wit as his clever stewardship of the central bank, coined an interesting phrase, “open-mouth operation”, taking off from the Open Market Operation tool of the RBI.

That phrase best describes RBI Deputy Governor Viral Acharya’s A.D. Shroff Memorial Lecture in Mumbai last week. Dr. Reddy had coined the phrase to describe his speech in Goa on August 15, 1997 at a conference of the Foreign Exchange Dealers’ Association. Then a Deputy Governor, Dr. Reddy (with the full support of the then Governor, C. Rangarajan) tried to talk down the rupee which the central bank felt was over-valued.

Compelling correctives

The objective of an “open-mouth operation” is clear: influence a target audience to behave in a manner favourable to you or your objectives. If the target was the forex market in Dr. Reddy’s Goa speech, it was the Central government in Dr. Acharya’s speech. The “open-mouth operation” worked beautifully in both instances. The rupee corrected immediately after Dr. Reddy’s speech; after Dr. Acharya’s speech, the government has been forced to acknowledge, even if grudgingly, that the RBI’s autonomy is “within the framework of the RBI Act”.


Shorn of the personalities, what we are witnessing now is a fascinating tussle between an institution covered by an Act of Parliament and the executive, with one fighting for its autonomy and the other for its interests. Where does the fair balance lie?

Before trying to answer that question, we need to understand the ‘autonomy’ that the RBI enjoys and the limits to that. This is not the first time that the RBI’s autonomy has come under focus, and it will surely not be the last. Successive Governors have fought against what they felt were transgressions — formal and informal — on the central bank’s autonomy by powerful Finance Ministers.

Dr. Reddy once famously quipped to a journalist: “I’m very independent. The RBI has full autonomy . I have taken the permission of my Finance Minster to tell you that.” On a more serious note, he clarified that the RBI is independent, but within the limits set by the government.


In his book, Advice and Dissent: My Life in Public Service , he explains his understanding of this autonomy under three functions: operational issues, policy matters, and structural reforms. In the case of the first, he believed in total freedom; on the second, he preferred prior consultation with the mandarins in North Block; and on the third, he worked in “very close coordination” with the government.

Dr. Reddy describes the interactions with the government as “walking on a razor’s edge” and concedes that the sovereign is ultimately supreme. That is because the RBI Act allows the government to give written directives to the RBI in the public interest (the infamous Section 7 that is now in the news). On critical issues, often the choice for the Governor is to concede to the government with or without a written directive. But tradition has been that both the government and the RBI have avoided recourse to this provision.

That has been due only to the mature handling of differences behind closed doors, something that has been absent in the current tussle. Duvvuri Subbarao, another former Governor, argues along similar lines in his book, Who Moved My Interest Rate?

Handled with care, till now

The existence of Section 7 in the RBI Act, even if it has never been used till now, proves that the RBI is not fully autonomous, says Dr. Subbarao. He points out that the fact that it has never been used is testimony to the sense of responsibility that the government and the central bank have displayed.


The statement put out by the government on Wednesday underlines this message very clearly: the RBI is autonomous but within the framework of the RBI Act. It is thus clear that the central bank cannot claim absolute autonomy. It is autonomy within the limits set by the government and its extent depends on the subject and the context. There is a clear reason why, even while it is conceded that control of the nation’s currency should be with an independent authority removed from the sway of elected representatives, the RBI Act has the veto option in the form of Section 7.

And that’s because it is not the technocrats and economists sitting in Mumbai’s Mint Street who carry the can for the policies they frame; it is the rulers in Delhi who do. Ultimately, it is the elected representative ruling the country who is answerable to the citizen every five years. The representative cannot split hairs before the voter while explaining the economy’s performance — he has to own up for everything, including the RBI’s actions, as his own.

In a democracy, it is unthinkable that we will have an institution that is so autonomous that it is not answerable to the people. The risk of such an institution is that it will impose its preferences on society against the latter’s will, which is undemocratic.

Seen from this perspective, the limits to the RBI’s autonomy will be clear. It is autonomous and accountable to the people ultimately, through the government. The onus is thus on responsible behaviour by both sides. There is enough creative tension between the two built into the system. The Governor has to be conscious of the limits to his autonomy at all times, and the government has to consider the advice coming from Mint Street in all seriousness, as indeed Dr. Reddy and Dr. Subbarao have pointed out.

Government’s failure

But what if they do have fundamental disagreements, as they seem to be having now, and are unable to arrive at a common ground? Well, the brahmastra of Section 7 is certainly available to the more powerful side; but just as the weapon is a deterrent never to be used, so is Section 7. The cleverness of the politician in Delhi lies in negotiating with the RBI and having his way without ever threatening to unleash the brahmastra — the other side knows it exists anyway. This is where the present dispensation in Delhi seems to have failed.

It is to avoid situations such as the one we are seeing now that former RBI Governor Raghuram Rajan argued for a clear enunciation of the RBI’s responsibilities. In his book I Do What I Do , he points out that the position of the RBI Governor in the government hierarchy is not defined. The Governor draws the salary of a Cabinet Secretary, and it is generally understood that he will explain his decisions only to the Prime Minister and the Finance Minister. Argues Dr. Rajan: “There is a danger in keeping the position ill-defined because the constant effort of the bureaucracy is to whittle down its power.”

The latest tussle between the executive and the central bank will eventually end, in all probability with a compromise. However, it’s purpose would have been served if the debate leads to greater awareness on both sides of the other’s compulsions. Better still, if it leads to a clear definition of the RBI’s responsibilities that would, to borrow Governor Urjit Patel’s words, be the pot of nectar coming out of this Samudra Manthan .

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