RBI Autonomy - de jure versus de facto



The RBI was established under the Reserve Bank of India Act, 1934 on April 1, 1935 as a private shareholders' bank, but since its nationalisation in 1949, is fully owned by the Government of India. The RBI is placed under the Entry 38 of List 1 of Schedule VII of the Constitution of India, which is the Union List.


The Preamble to the RBI Act describes the basic objective as "to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally, to operate the currency and credit system of the country to its advantage". Thus, there is no explicit mandate for price-stability or formal inflation targeting. The twin objectives of monetary policy in India have evolved over the years as those of maintaining price stability and ensuring adequate flow of credit to facilitate the growth process. The relative emphasis between the twin objectives is modulated as per the prevailing circumstances and is articulated in the policy statements. Consideration of macroeconomic and financial stability is also subsumed in the articulation of policy.
The RBI is also entrusted with the management of foreign exchange reserves, which are reflected in its balance sheet. While RBI is essentially a monetary authority, its founding statute mandates it to be the manager of public debt of the Government of India and banker to the Government. In terms of Section 20 of the RBI Act 1934, RBI has the obligation to undertake the receipts and payments of the Central Government and to carry out the exchange, remittance and other banking operations, including the management of the public debt of the Union. In the recent past, a functional separation of monetary and debt management was debated and the Union Budget for 2007-08 has announced a proposal to setting up of an autonomous Debt Management Office to keep the debt management distinct from monetary management. Further, as per Section 21 of the said Act, RBI has the right to transact Government business of the Union in India.
While, as per statute, RBI is the monetary authority of the country, the RBI has also been entrusted with the work relating to Banking and Supervision by an enactment in 1949. The RBI exercised a tight regime of exchange control particularly under the Foreign Exchange Regulation Act (FERA), 1973; but, a qualitative change was brought about in the legal framework to enable liberalization by the enactment of the Foreign Exchange Management Act (FEMA) in June 2000 replacing the earlier FERA. With this, the objectives of regulation have been redefined as facilitating trade and payments as well as orderly development and functioning of foreign exchange market in India.

It is significant to note that the RBI Act, Section 19 precludes (prevents) RBI from performing certain business which protects the integrity of the institution, such as trading or taking any direct interest in commercial, industrial or other undertaking, purchasing shares or giving loans against shares, and advancing money on security of immovable property, drawing or accepting bills payable otherwise than on demand. Because of the last provision, the RBI evolved the Market Stabilisation Scheme through an MoU with the Government, for undertaking stabilisation operations.


On practical considerations, central bank independence may be viewed as related broadly to three areas, viz., management including personnel matters; financial aspects; and conduct of policy. Managerial independence refers to the procedures for appointment, term of office and dismissal procedures of top central bank officials and the governing board. It also includes the extent and nature of representation of the Government in the governing body of the central bank and Government’s powers to issue directions. Financial independence relates to the freedom of the central bank to decide the extent to which Government expenditure is either directly or indirectly financed via central bank credits. Direct or automatic access of Government to central bank credits would naturally imply that monetary policy is subordinated to fiscal policy. Finally, policy independence is related to the flexibility given to the central bank in the formulation and execution of monetary policy, under a given mandate.

While the Central Government may give such directions to the RBI after consulting the Governor as it may consider necessary in the public interest, the overall management of the Bank’s affairs and business rests with the Central Board of Directors. The Governor is appointed by the Central Government and may be removed from office without specifying any reason. All Deputy Governors are also appointed by the Central Government and may be similarly removed. All Directors of the Central Board are nominated by the Central Government with one Government official as a participant in the Board deliberations. The Directors hold office during the pleasure of the Central Government which can also supersede the RBI’s Central Board.

The staffing pattern is left to the RBI, but rules governing their service conditions and compensation are not out of alignment with public sector in general and banking sector in particular. There is legal protection to the Bank and also to its officers for actions taken in good faith. There have been no noticeable changes in the recent past in the relationship between the Government and RBI on managerial/personnel matters.

On financial aspects of RBI vis-à-vis Government, however, there have been several positive developments. Since the 1990s, as the case for according greater operational flexibility to the RBI in the conduct of monetary policy and regulation of the financial system became stronger, the practice of automatic monetisation of the Government’s fiscal deficit through the issue of ad hoc treasury bills came under severe criticism (Rangarajan, 1993). In subsequent years, the phasing out of automatic monetisation of fiscal deficits by 1997 and the enactment of FRBM legislation in 2003 are two important milestones in the direction of providing safeguards to monetary policy from the consequences of expansionary fiscal policy and ensuring a degree of de facto autonomy of the RBI.
It is interesting to note that the above autonomy in financial matters was obtained by the RBI through exchange of letters and agreements whereby automatic monetisation through ad hoc Treasury Bills was discontinued since April 1997. The Fiscal Responsibility and Budget Management (FRBM) Act, 2003, further strengthened the position by prohibiting the RBI from participating in primary issuances of all government securities.

The RBI has gradually withdrawn from the practice of providing concessional finance or refinance for specified sectors such as agriculture, industry and export, though the legal provisions continue to enable it. In the same view, as part of strengthening monetary management, only notional provisions are made out of RBI profits for Agriculture, Industrial and Housing Credit Funds. No doubt, there are persistent demands on RBI to reverse the process, but the RBI advocates direct fiscal support to development activities so as to be transparent, accountable and quantifiable rather than through monetary operations of RBI, which would tantamount to quasi-fiscal operations.

Transfer of the balance of profits, after necessary provisions, to the Central Government has been rationalised as part of the reform process in 1997. The present arrangement is governed by the objective of reaching a stipulated level of reserves in RBI’s balance sheet over a period – though the timeframe to reach the level is extended by mutual consent to accommodate immediate fiscal compulsions.
In technical parlance, accountability of an institution like RBI goes together with a specific mandate and operational independence or autonomy to achieve the said mandate. In the absence of these, in practice, the RBI is accountable indirectly to Parliament through the Ministry of Finance, Government of India. At times, it is summoned by Parliamentary Committees, and even in such cases, it generally plays only a supportive role to the executive wing of the government.

In a recent IMF Working Paper published in April 2007, where the indices of central bank autonomy have been calculated for 163 central banks as of end-2003, in a group of 32 emerging markets, India has scored 0.25 for political autonomy of the central bank as against the average score of 0.56 for the group of emerging markets and scored 0.75 for economic autonomy of the central bank which is the same as the average score for that group.

Dr. Bimal Jalan at the time of laying down office as Governor in 2003 remarked: "the autonomy of a central bank is best set by convention rather than by statute, especially in emerging countries. There should be harmony between the government and the central bank with shared objectives, though the instrumentalities in achieving the objectives may be different”.

Harmonious relations between Government and RBI have no doubt generally contributed to the successful policy outcomes thus far, but it would not be appropriate to conclude that there are no differences in analysis, approaches, judgements and instrumentalities. In the given legal and cultural context, while making every effort to give its views either informally or formally, but as unambiguously as possible, the RBI generally respects the wishes and final inclination of the government. The RBI, however, has to accept the responsibility for all its decisions and actions, while being generally conscious of the impact of its articulation and actions on the credibility for central banks operations. The Government, for its part, recognises the dilemmas posed to RBI, and accord significant weight to central bank’s judgements.

Monday, 08th Feb 2016, 10:54:29 AM

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