Narendra Modi suffered electoral losses in the same week as the central bank changed leadership

The Indian government wants the Reserve Bank of India to transfer more money into its coffers. Many say this demand was a leading reason for the resignation of Urjit Patel, the central bank’s previous governor, last month.

Yet this is just one of several points of friction between the government of Narendra Modi and the RBI. This friction risks damaging the RBI and the credibility of Indian economic policy. It is important for the central bank and government to work together harmoniously; it is no less vital that the RBI retains credible autonomy when executing its core functions.

In addition to the question of transfers from the RBI, the government fears the central bank is allowing the economy to become too weak and inflation too low. With a general election now close, it also wants the RBI to encourage more bank lending, including from 11 undercapitalised public sector banks; improve liquidity for non-bank financial companies; and increase the flow of credit to small businesses. Yet it is also necessary to recall that, back in November 2016, the government foisted the policy of demonetisation on the RBI. That was a big shock and remains controversial.

This is now a fractious relationship. That is not surprising. Mr Modi has centralised power in his administration to a high degree and evidently desires greater control over the central bank. History is also on Mr Modi’s side. The RBI has long been subservient to the central government and recent moves towards more independence remain limited.

Bimal Jalan, a former RBI governor, put forward no more than the widely accepted view when he insisted the RBI is accountable to the government and must make policies within the framework set by the government. What makes his statement more significant is that he has been put in charge of the panel responsible for framing guidelines for the transfer of supposedly surplus RBI capital.

From a technical point of view, the government has a strong case. It owns the RBI, which, as is true of all central banks, is profitable. Some or all of those profits should (and do) accrue to the fiscal budget. It is conventional wisdom among central bankers that their institutions need positive net worth if they are to perform their functions successfully. But the RBI is extraordinarily well capitalised, with a ratio of equity to assets of 28 per cent, against a global average of around 8 per cent.

The government’s view that this is “its” money is also correct. So why should it not put it to better use? Against this, some argue that the high net worth is mainly the result of the depreciation of the rupee, which might reverse. Raghuram Rajan, Mr Patel’s predecessor, argues the strength of the RBI’s balance sheet also allows it to borrow cheaply. Yet it is not obvious even these arguments justify such a huge net worth. Arvind Subramanian, former chief economic adviser, agrees that using the RBI’s “excess” capital to fund current spending would be wrong. But, he argues, its use in recapitalising public sector banks would be quite a different matter.

Of the issues between the RBI and the government, this is far from the most important. It should surely be possible to reach a compromise. The worry is that the history of friction, culminating in the recent appointment as governor of Shaktikanta Das, a former finance ministry official, makes it look as though the RBI is being suborned for political purposes. It is vital that the RBI is seen to carry out its core functions in a fully professional manner. Mr Modi must beware. The loss of the RBI’s credibility would damage India.

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