At the heart of any modern democracy lies the doctrine of separation of powers, which ensures division of responsibilities and also structurally validates a key principle of governance, i.e., allowing each institution to function autonomously, while still maintaining accountability within the larger legislative framework. In codifying its own unique (and somewhat limited) interpretation of this doctrine, the Constitution of India delineates functions of the Union and the states, allowing Parliament to legislate on the functions of key agencies such as the Central Bureau of Investigation and the Reserve Bank of India (Entry 38, Seventh Schedule).
In the past few years, the Reserve Bank of India (RBI) has had its work cut out, with rising non-performing assets and inflationary pressures prompting tough talk and action at its end. As a central bank, the RBI’s approach and policies have been driven by its own long term macro-economic imperatives but Central Government, in contrast, has a multitude of other concerns (typically short term) that compel it to approach policy decisions differently. Naturally, this has led to discord between the RBI and the current Central Government, as laid bare in the aftermath of the meeting of the RBI Board on October 23, 2018. Following the meeting came reports of the Government possibly invoking Section 7 of the RBI Act, 1934 (RBI Act), which gives it the power to issue directions to the RBI.
Since then, the stand-off between the Government and the RBI has been riding high on news cycles over the past few weeks and, given upcoming elections, has been getting the kind of mainstream media attention usually reserved for celebrity weddings. The politicisation of this fracas was inevitable, as was the influx of literature (ranging from economic analysis to polarised opinion pieces) that is now available in the public domain on this.
This piece, though, focusses on the legal underpinnings of this saga and, in doing so, discusses the legal framework that governs the interaction between today’s Central Bank and Government, including a comparison with other jurisdictions. It then concludes with an analysis of whether the proposals of the Financial Sector Legislative Reforms Commission (FSLRC) could have helped create an institutional safety valve (at best) or at least a viable resolution mechanism for such stalemates.
Applicable Legal Framework in India
Section 7 of the RBI Act empowers Central Government to give such directions to the RBI as it may, after consultation with the RBI Governor, consider necessary in the public interest. At the outset, the directions are required to be preceded by consultations with the Governor and have to pass the test of being necessary in the public interest. This in itself, may not be challenging. “Public interest” is a wide term and does not have any specific meaning ascribed to it in the RBI Act either. Further, it is an accepted principle of administrative and constitutional law that the executive does not have carte blanche when it is required to satisfy itself of necessity before proceeding with certain actions; rather it should review actions, judicial or otherwise, with great restraint and circumspection. The requirement of consultation with the Governor is in keeping with the larger concept of checks and balances; however, the ultimate authority seems to vest with Central Government itself. It is also hard to imagine a situation in which a direction will be issued, if the Governor and Central Government were in agreement to begin with.
Also relevant to note is the fact that the general superintendence and direction of the affairs and business of the RBI have been entrusted to a Board, in whose appointment Central Government plays an important role. The Board itself comprises of a Governor and not more than four Deputy Governors (to be appointed by Central Government); four representatives of local RBI boards, ten Directors and two Government officials, all to be nominated by Central Government.
Section 30 of the RBI Act also sets out the manner in which Central Government may supersede the Board, which requires a full report of the circumstances and the action taken to be laid before Parliament at the earliest possible opportunity and in any case within three months from the notification to this effect.
Similar provisions exist for other regulators as well. The Securities and Exchange Board of India (SEBI) is a good example, where the Securities and Exchange Board of India Act, 1992, contains provisions under which SEBI is bound by the directions of Central Government on questions of policy. While Central Government has the powers to make appointments to the SEBI Board, it is also empowered to supersede SEBI for a period of six months. Similar powers exist under the Insurance Regulatory and Development Authority of India Act, 1999, as well.
Therefore, the legislative superstructure allows for all financial sector regulators to remain independent but when inclined, there is sufficient statutory basis for Central Government to intervene.
Scrimmages between governments and central banks are far from unique to India. The US Federal Reserve has also been facing flak from the Government recently (admittedly a rare occurrence), which has raised debates on its institutional independence. In fact, a significant amount of research and empirical studies have analysed central bank independence and its correlation with other macro indicators. Some studies have also delved into the nuanced aspects of interactions between governments and central banks.
For instance, in a paper titled, “The relationship between the central bank and the government” by Paul Moser-Boehm at a special meeting of governors held at the Bank for International Settlements (BIS), Basel, 14-15 March 2006, an analysis was undertaken of the nature of meetings and contact between the central bank and their governments, including frequency and purpose of formal meetings, as well as informal contact. The paper observed that the purposes of meetings involving the Governor tend to be more wide-ranging, with greater informal contact in emerging market economies than in industrialised countries. It concluded that this probably reflects the often broader range of mandates of central banks in emerging rather than industrialised economies.
On an examination of the framework in place in the US, UK, Euro Area, Japan and Canada, it is clear that the central banks in these jurisdictions have been set up in a manner that enables them to function independently, albeit attendant safeguards may vary. In the US, UK, Japan and Canada, central bank independence is enshrined in laws, much like India, and any significant departure to the manner of functioning can only be made by amending such laws.
However, as a function of the Euro Area framework itself, the European Central Bank’s (ECB) independence is set out in an international treaty, changes to which would require ratification from the member states, providing a greater assurance of autonomy. The treaty not only prohibits the ECB from seeking or taking instruction from any institution, government or other body but also prohibits governments and other institutions from influencing the decision-making bodies of the ECB.
In the UK specifically, the parliament has the power to override decisions of the central bank, i.e. the Bank of England, in extreme circumstances. In Canada as well, there is a possibility of a written directive concerning monetary policy being issued, which the central bank would have to comply with.
Some experts consider the existence of such directive clauses an important instrument of democratic accountability, provided it is not unconditional and subject to review. Keeping these objectives of accountability and transparency in mind, and given the impact the central bank policies have on an economy, there is indeed reason to accept directive clauses, provided there are sufficient safeguards to ensure continued independence of the central bank.
Where is the Safety Valve?
The FSLRC, as a part of its wide ranging mandate, had identified the Financial Sector Development Council (FSDC) as the central intercessor across all regulators in its 2013 report. However, even the FSDC was proposed to be chaired by the Finance Minister with heads of regulatory agencies as its other members, thereby allowing the Government to have significant influence on a number of issues, including systemic risk regulation and crisis management/resolution.
Subsequent to the recommendations of the FSLRC, the Monetary Policy Committee was created in 2016 with the view that a committee-based approach for determining the monetary policy will add a lot of value and transparency to decision-making. Most importantly, the RBI Act itself requires Central Government to appoint as members, persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy. It is interesting to note that the FSLRC had also included the requirement of ensuring that Central Government appointees have expertise in dealing with matters relating to banking, payments and monetary policy. The independence of any central bank is admittedly conducive to price-stability and long term growth and perhaps now is the time to also take a relook at the composition of the Board to ensure that the RBI remains a technocracy.
Central Government and the RBI seem to have agreed on a temporary truce, but it will be interesting to watch this through to its end, given the upcoming elections.