MUMBAI (REUTERS) - In a sign of a mounting policy struggle between India's central bank and the government of Prime Minister Narendra Modi, a top bank official warned on Friday (Oct 26) that undermining a central bank's independence could be "potentially catastrophic".
The comments by Reserve Bank of India (RBI) deputy governor Viral Acharya showed that the central bank is pushing back hard against government pressure to relax its policies and reduce its powers ahead of a general election due by next May, and as Indian financial markets have been dropping in recent weeks.
In a speech to top industrialists, he cited the Argentine government's meddling in its central bank's affairs in 2010 as an example of what can go wrong. That led to an investor revolt and a surge in bond yields, badly hurting the South American nation's economy.
"Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution," Acharya said.
He had three of his fellow deputy governors in the audience and also thanked RBI Governor Urjit Patel for his "suggestion to explore this theme for a speech", in a show of unity from an institution typically known for its restraint.
Government officials have recently called for the RBI to relax its lending restrictions on some banks, and New Delhi has also been trying to trim the RBI's regulatory powers by setting up a new regulator for the country's payments system.
Acharya said more needed to be done to ensure effective independence for the central bank in its regulatory and supervisory powers.
"The risks of undermining the central bank's independence are potentially catastrophic," said Acharya, adding that rash moves could trigger a "crisis of confidence in capital markets that are tapped by governments and others in the economy".
Finance Ministry spokesman D.S. Malik said on Saturday (Oct 27) that he had read Acharya's statement but declined to comment on it without consulting senior officials. Finance Minister Arun Jaitley was due to speak at a scheduled event in New Delhi later on Saturday, he added.
"There's no chance to accept RBI's demand to give it full freedom," a government source told Reuters before Acharya's speech on Friday. "It is also accountable to Parliament like every institution."
Government officials have also called for the central bank to ease its lending restrictions on some banks that have a low capital base.
The RBI has identified 11 such state-run banks that are barred from lending unless they shore up their capital base after a massive rise in bad debts on their balance sheets.
Last week, the RBI also published an unprecedented note expressing its opposition to the government's moves to establish a separate regulator for the payments system, which is currently handled by the RBI as part of its functions related to banking regulations.
Acharya reiterated the need for a central bank to fortify its balance sheet against external shocks in the face of government demands to transfer surplus reserves to government coffers.
Modi is under pressure as higher international oil prices have hurt the rupee currency and driven Indian fuel prices to record highs, leading to protests.
Stock markets, which scaled new highs in August, have since given up all of their gains for the year amid fears of a liquidity crisis among non-banking financial companies (NBFCs), in the aftermath of defaults by a major infrastructure financing company.
Modi's government has also faced corruption allegations from the opposition Congress party over a military jet deal with France, and this week it faced protests over its move to suspend the chief of India's top crime-fighting bureau.
WORK IN PROGRESS
Acharya, who is in charge of departments including monetary policy and exchange rate markets, also defended the central bank on its effectiveness following a pile-up of bad debt worth US$150 billion (S$207 billion) in banks. He said that the bank was "statutorily limited" in taking a full scope of actions against state-run banks.
Referring to NBFCs, Acharya said that systemic risks can build in shadow banks when important parts of financial intermediation are kept outside the purview of the central bank. He warned this could come at "substantive costs to future generations in the form of unchecked financial fragility".
While the RBI is not statutorily independent, as the governor is appointed by the government, it enjoys broad autonomy in setting rates.
"There should be a balance between autonomy and accountability," said former RBI deputy governor H.R. Khan.
"For example we have an inflation targeting model now and the central bank is accountable for its inflation targeting. Similarly there can be such autonomy and accountability for financial sector regulation by creating some desirable objectives."
Acharya acknowledged the government's efforts to bring in legislative changes that allowed setting up a monetary policy committee in 2016 and distancing itself from monetary policy decision-making.
Those "who invest in central bank independence will enjoy lower costs of borrowing, the love of international investors, and longer lifespans", he added.