Urjit Patel stepped down from his position as governor of the Reserve Bank of India (RBI) on Monday, but the news was neither a shock or an event without precedent.
There have been similar occurrences in recent Indian history. The departure of Patel was simply the latest in a pattern of high-profile resignations from powerful positions in institutions that are mandated, critically, with ensuring the country’s financial well-being.
In this, the National Democratic Alliance government led by Prime Minister Narendra Modi has shown serious mismanagement. Modi and Finance Minister Jaitley combined have drawn resignations from economists like Raghuram Rajan, Arvind Panagariya, Arvind Subramanian, and Urjit Patel.
And shortly after, it was revealed that Surjit Bhalla, another eminent economist, had also stepped down from the PM’s Economic Advisory Committee.
These developments do not, of course, exist in isolation. Most significantly, they further dent an already slipping Indian economy.
Battle over RBI independence
Urjit Patel’s resignation has been in the making for some time. The RBI Deputy Governor Viral Acharya, in a speech at the AD Shroff Memorial Lecture in Mumbai in October, warned the government of “catastrophic consequences if RBI’s independence is curbed.”
The government has repeatedly endangered the autonomy of the institution, with matters coming to a head when it threatened to invoke Section 7 of the Reserve Bank of India Act, 1934, which empowers the government to issue directions to the RBI Governor.
Importantly, Patel was the government’s own chosen appointee following the departure of Rajan’s departure in June 2016. He was led to resign, reportedly in a bid to save the RBI’s autonomy, and as a protest against government meddling in the institution’s affairs.
Ultimately, there are several indicators of governmental overreach, all triggered by political motives, that have come together to compound the crisis.
The first point of departure is the continuing tussle over interest rates, involving an inflation-focused RBI keen on keeping interest rates intact or even increasing them. This led to government displeasure at a time when it was interested in seeing interest rates lowered to boost spending.
Second, the RBI’s circular on 12 February 2018 relating to the classification of non-performing assets (NPAs) and norms of loan restructuring played a significant role in creating further tension between the government and itself.
The government found the implications of the circular to be particularly harsh for the SME sector, which is already struggling under the impact of demonetization and GST. Eventually, pressure from the government forced the central bank to announce a plan for a loan-restructuring scheme for small businesses with a loan exposure of up to INR 25 crore (US$3.47 million).
The Nirav Modi scam is a third factor adding to existing cleavages, with the government, in an attempt to distance itself, putting the entire onus of not following procedural scrutiny on the RBI. As a result, the central bank sought more power to oversee public sector banks to ensure their parity with private sector peers.
This request was denied by the government because it would allow increased RBI oversight of Public Sector Undertaking (PSU) Banks, an area traditionally controlled by the government.
Finally, other issues that put the RBI and the government at cross-purposes relate to disagreement over the size of the central bank’s reserves and the RBI’s refusal to provide relief to Non-Banking Financial Companies (NBFCs) that are grappling with a cash crunch after Infrastructural Leasing & Financial Services (IL&FS) defaulted on repayments.
Central bank’s autonomy overlooked
As NBFCs have grown, they have emerged as another source of last-mile funding in places where banks cannot reach. On this basis, the government mooted the idea of introducing a special window to assist cash-strapped NBFCs.
The RBI rejected this proposition, stating that it had already taken enough measures to normalize the liquidity, and that following these steps, it was the Non-Banking Financial Companies’ responsibility to secure their own liquidity.
In theory, and in the spirit of checks and balances, the RBI is held accountable to government but autonomous of it. The Modi government, however, appears to have taken undue advantage of the RBI’s accountability while entirely overlooking its autonomous aspect.
This is against the backdrop of the law as per which the RBI falls under government control, which means that the argument of autonomy is already weakened right off the bat.
The economic instability that we have witnessed over the past few years that has been thrown into much sharper relief with Urjit Patel’s resignation will undoubtedly impact on markets in the short-term.
Even more noteworthy, however, is its confirmation of institutional jeopardy that will have severe repercussions for the Indian economy in the long-run.
Prerana Priyadarshi is a senior researcher at the Centre for Internal and Regional Security (IReS), in the Institute of Peace and Conflict Studies (IPCS), New Delhi.