Public sparring between the central government and the central bank is not healthy for an economy like India, cautioned former Reserve Bank of India Deputy Governor Rakesh Mohan. Such tussles distract from the functioning of the Reserve Bank and impact the confidence that markets and observers have in the country’s central bank, Mohan said in an interview with BloombergQuint.
“The government should refrain from airing such differences publicly and, of course, that goes the other way around as well,” said Mohan while adding that he is not privy to the provocations that led the RBI to come out so publicly. “I do hope that saner heads will prevail.”
On Friday, RBI Deputy Governor Viral Acharya, in a public speech, aired concerns over some of the ways in which the government could impinge on the central bank’s independence. “Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets...” Acharya cautioned.
Mohan took a nuanced view. There must be a high degree of autonomy for the central bank but complete independence of the central bank is difficult in a developing economy like India, he said.
“I have a mixed view on this. I think the central bank needs to have a very high degree of autonomy but at the same time, given the level of the development of our economy, it is very important that the government and the Reserve Bank be seen as being on the same page. There will always be differences but they should be resolved privately and a consensus should be evolved on what needs to be done. “Rakesh Mohan, Former Deputy Governor, RBI
RBI’s Reserves And Capital
Issues raised by Acharya included suggestions by the government that the RBI increase the dividend payout to the government and transfer some of the capital on the central bank’s balance sheet. Acharya, who cited recent writings from Mohan in the Business Standard, argued that a central bank needs a strong balance sheet to perform its full range of critical functions.
Mohan said the issue is two-fold.
One issue is the formula used to calculate the transfer of dividend. This formula has been devised by expert committees which have looked into the RBI’s accounts over the years, said Mohan.
“The RBI Act makes it clear that all the profits of the Reserve Bank must be transferred to the government. The issue is what are the profits based on the accounting method used. It is clear that given the risks that the RBI undergoes, that it is important for the RBI to make provisions for various contingencies.”
The risks that the RBI may face include volatility in foreign exchange markets, a fall in the value of the government bonds it holds, losses incurred via sterilisation methods used such as open market operations, and possible credit risks arising from the RBI’s ‘lender of last resort’ function.
“It is prudent accounting to make adequate provisions for coping with these risks,” Mohan said. It is best that there is a “clean formula” on this, he added.
“Such provisioning adds to the confidence that the market has in the central bank,” said Mohan.
Commenting on the argument made by former Chief Economic Adviser Arvind Subramanian that the RBI holds too much capital, Mohan said the central bank’s assets are equal to 20 percent GDP for some time now. This is not very different from the balance sheet of the US Federal Reserve at present, or the European Central Bank, the Bank of England and the Bank of Japan.
“It is a little surprising to see arguments that the RBI needs to transfer the capital to the government,” said Mohan while adding that any gains from such a transfer would be illusory.
Regulation Of Payments
Mohan also came out strongly in support of the RBI’s position that payment regulation must stay under its umbrella.
An inter-departmental committee set up to suggest reforms to India’s payment laws recommended setting up an independent payments regulator, outside the RBI. The central bank issued a public dissent note on the decision, saying that payment systems are a subset of the central bank’s core function of currency management.
Mohan shares that view.
Mohan said his research suggests that most of the top 20 central banks have payment regulation under them. Only in the US and Canada do the central banks not have payments within their exclusive domains.
“A core function of central banks is currency. Payment and settlement systems are only extensions of currency. What are payments? It is the transfer of money in different forms. Therefore, the regulation of payment and settlement systems, which are the backbone of the economy, has to be with the central bank. There is no question about this.”Rakesh Mohan, Former Deputy Governor, RBI
Mohan, however, acknowledged that the technological development in the field of payments may warrant the central bank bringing in more technical assistance from the outside. “But to say that payment system regulation should be taken away from the Reserve Bank makes no sense at all...I can’t understand where such an idea comes from.”
Mohan also questioned which body, other than the RBI, would have the expertise to manage the payment systems more effectively.
RBI’s Performance
While supporting the RBI’s autonomy, Mohan noted that the institution must show the strength and performance to earn that autonomy.
In his articles for the Business Standard, Mohan said that the RBI had dealt with a number of challenges such as the Asian financial crisis and the global financial crisis well. However, issues such as the period of high inflation around 2013, the build-up of bad loans and the recent instances of banking frauds have dented its track record. RBI's regulatory and supervisory apparatus may need to be re-examined and modernised, Mohan wrote.
Speaking to BloombergQuint, Mohan said the time is right to strengthen the professional and technical strength of the RBI.
“The size of the Indian financial system has grown by leaps and bounds over the last 20 years... Yet the technical and professional strength of the RBI has remained the same,” Mohan pointed out.
“Given the kind of complexity there is now and the magnitude of banking and financial services that exists in the country now, there needs to be a serious relook at the size of the professional staff at the RBI as well as their technical competence.”
As part of this, the government and the RBI may also need to allow significant lateral entry into the Reserve Bank, said Mohan while adding that not enough attention is being given to this issue.
(This article was originally published on BloombergQuint)
Watch the full interview here:
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