Rajan sees room for disagreement between RBI and government

Former Reserve Bank of India governor Raghuram Rajan downplayed the spat between the central bank and government on November 6, while warning of potential dangers if the row escalates.

Rajan said it was natural for the government to want to “push” growth, but the RBI had to lean against that desire whenever it threatened the financial stability mandate.

“The government always pushes. There were innumerable letters on my table coming from government, saying ‘relax this, relax that, relax something else’,” he said. “They knew we would look at the letter carefully and take a view… and then when we said ‘no’, they would say ‘fine’.” Shortly after, the next letter would arrive, he added.

Because the RBI would be “held to task” in the event of financial stability problems, it needed the power to say no to the government, Rajan said during an interview with India’s ET Now business news channel.

There could be more serious consequences if the government invokes the hitherto unused Section 7 of the RBI Act. This provision allows the government to issue directions to the central bank and could be used to force the RBI to transfer reserves to the government, which is struggling to curb its budget deficit.

“I do believe when the relation gets so precarious that [Section 7] has to be invoked, we have to be very worried,” said Rajan.

Tensions between the RBI and government came to a head in late October, when deputy governor Viral Acharya gave a speech warning that the government could “incur the wrath” of financial markets if it tampered with central bank independence. Governor Urjit Patel has reportedly threatened to resign if the government does invoke Section 7.

I do believe when the relation gets so precarious that [Section 7] has to be invoked, we have to be very worried

Raghuram Rajan, formerly of Reserve Bank of India

Nevertheless, Rajan saw room for a relationship between the RBI and government based on mutual respect. “It’s when you encroach on each other’s territory that it becomes problematic,” he added.

The former governor likened the central bank to a seatbelt – it might restrict your movement somewhat, but in a crash you are glad of it.

Rajan also noted the need for policy-makers to do more to improve macroeconomic stability. India is suffering from “twin deficits” – current account and government budget – which “doesn’t look that good” for an outside investor, he said.

The government has been in fiscal consolidation mode for five years, but Rajan said the deficit was still hovering at around 7% of GDP due to lax fiscal discipline among the states. Markets would not be “fooled” if the government failed to bring the problem under control.