AUTONOMY OF RESERVE BANK OF INDIA IN THE REGULATORY

FRAMEWORK OF INDIAN FINANCIAL SYSTEM: A WAY TO A

DEVELOPED INDIA

ABSTRACT

As a monetary authority and regulator of the financial system, Reserve Bank of India has
done a commendable job. This paper has focused on the role played by RBI in the regulatory
framework of Indian financial system as a regulator and supervisor and also analyzed
whether granting autonomy to RBI can contribute to the growth of the country. Review of
literature has shown that majority of the central banks in the world only have instrumental
independence which shows that the central banks are free to only choose the means to
achieve the objectives set by the government and many of the central banks have also shown
the evidence of the government’s influence on its decision making. Doing Business Report
2014(World Bank), investigating the regulations that enhance or constrain business activity,
has placed India at low ranks in almost all parameters. Furthermore inflation and
independence of a central bank has been seen to have an inverse relation. Secondary data
along with supporting primary data were adopted for collecting the requisite information for
this study. The study has revealed that if RBI achieves autonomy along with ensured
accountability it can help the fiscal system to tone up and ensure more transparency in the
entire budget making process. It is seen important for the government and the regulators in
India to develop conventions and practices which will serve the goal of preserving financial
stability without eroding the autonomy of the regulators for the growth of its economy. The
Development Financial Institution at the international level IMF has also suggested making
the RBI free from the government’s influence by removing certain provisions from the law
which can undermine its independence from the government.

Keywords: Reserve Bank of India Autonomy , Autonomy of central banks, Central

Bank of India, Financial Development

INTRODUCTION

The Reserve Bank of India is the central bank of the country. It was set up on the basis of the
recommendations of the Royal Commission on Indian Currency and Finance which is also
known as Hilton-Young Commission.[ CITATION Res14 \l 1033 ] As the central banking
authority of the country, it has the responsibility to ensure harmonious and balanced growth
of all banking constituents and avoiding at the same time unhealthy competition among them.
[ CITATION SNM05 \l 1033 ]

An interesting feature of Reserve Bank of India is that at its very inception, the bank was
seen as playing a special role in the context of development, especially agriculture. The Bank
was also instrumental in institutional development and helped to set up institution like the
Deposit Insurance and Credit Guarantee Corporation of India, the Unit Trust of India, the
Industrial Development Bank of India, the National Bank for Agriculture and Rural
Development, the Discount and Finance House of India etc. to build the financial
infrastructure of the country. With liberalization, the bank’s focus has shifted back to core
banking like Monetary Policy, bank supervision and regulation and overseeing and onto
developing the financial markets.[ CITATION Res14 \l 1033 ]

The functions of Reserve Bank of India can broadly be divided into three categories: central
banking functions, supervisory functions and promotional functions. Central banking
functions include issue of bank notes, functioning as banker to the Government, banker’s
bank, custodian of foreign exchange reserves, controller of credit, etc.

In order to promote and develop a sound and efficient system of banking in India, the
Reserve Bank of India has been given several supervisory powers over different banking
institutions. These powers relate to licencing and establishment, branch expansion, liquidity
of assets, management, working, amalgamation, reconstruction and liquidation of commercial
and cooperative banks. The Reserve Bank of India carries out periodical inspections of these
banks and calls for such information which it considers necessary for effective performance
of its functions.

The Reserve Bank of India as a Central Bank of the country has assumed greater
responsibilities as development and promotional agency as compared to a mere monetary
authority. It not only controls the credit and currency in the economy or maintains
internal/external value of the rupee for ensuring price stability but also acts as a promoter of
financial institutions, required for meeting specific financial requirements of the developing
economy.

As per the Reserve Bank of India Act, 1934 the Central Government may from time to time
give such directions to the Bank as it may, after consultation with the Governor of the Bank,
which it considers necessary in the public interest. [ CITATION RES14 \l 1033 ] This Act has also
given powers to the Central Government to supersede the decisions of the Central Board of
directors of Reserve Bank of India. Such provisions are creating difficulty for RBI to act as
an autonomous body. Moreover after making provisions for bad and doubtful debts,
depreciation in assets etc, the balance of the profits are to be paid to the Central Government.
If the Reserve Bank of India gets full autonomy then this surplus profit could be utilised for
purposes of interests of the central bank’s primary goals.

Former RBI governor Dr. Y.V. Reddy at Indian Institute of Management at Indore on
October 3, 2001 stated in his speech that recent literature has stressed the difference between
goal independence and instrument independence. He said goal independence refers to a
situation where the central bank itself can choose the policy priorities of stabilising output or
prices at any given point of time, thus setting the goal of monetary policy whereas instrument
independence implies that the central bank is only free to choose the means to achieve the
objective set by the Government. He mentioned that in a survey (Fry. M, et al 1999) of
central banks, 40 of the total 56 central banks across a broad range of economies defined
independence predominantly in terms of instrument independence and of the remaining 16
responses, many highlighted factors that had implications for the relationship between the
Government and the central bank. He also added that in recent years, as a secondary solution
to the deficit problem, some public choice theorists put forward the case of an independent
central bank. He said that the basic contentions of these economists are: unless there are
constitutional or institutional constraints to the contrary, a democracy contains a bias towards
deficit finance; thus they operate within the premise that politicians do not necessarily pursue
public interest but are more concerned with their personal or political agenda. Also,
according to him an inverse relationship between central bank independence and the level of
inflation is supported by most empirical studies during the post Bretton-Woods
period[ CITATION DrY14 \l 1033 ].

Backing the central bank’s case for autonomy, the International Monetary Fund said it would
be beneficial to remove certain provisions in the existing Banking Regulation Law and the
Reserve Bank of India Act which allow the Central Government to give directions to the
Reserve Bank of India, to require it to perform inspections, to overrule decisions and to
supersede the RBI Board, to ensure independence of the Reserve Bank of India. In its
financial sector assessment programme for the country, the Fund pointed out that the
independence of the Reserve Bank of India is not enshrined in the law and there are some
legal provisions that could seriously undermine its independence from the Government
[ CITATION Nee14 \l 1033 ].

To tone up the fiscal system, the government must extend autonomy to the Reserve Bank of
India and bring in more transparency into the entire budget making process, NK Singh,
former revenue secretary and Rajya Sabha member had said in 2008[ CITATION Aut14 \l 1033 ].

Doing Business Report 2014(World Bank), investigating the regulations that enhance or
constrain business activity, has placed India at 134 th on Rankings on the ease of doing
business and the lack of autonomy of Reserve Bank of India can also be considered as a
parameter for this low ranking[ CITATION Doi14 \l 1033 ].

Favouring greater autonomy, Reserve Bank’s former Governor D Subbarao in his speech at
SAARC Finance Governors’ symposium at Kumarakom in Kerala said “having autonomy
frees central bank from pressure of responding to short-term developments, deviating from its
inflation target and thereby compromising its medium term inflation goals.” Subbarao also
pointed out that with central banks assuming increasing responsibility for financial stability,
autonomy question has acquired an additional dimension and greater urgency[ CITATION
Nee11 \l 1033 ].

Reserve Bank’s former Governor D Subbarao also added in his lecture on "Changing Role of
Reserve Bank of India " at the year-long concluding event of the golden jubilee celebrations
of Reserve Bank Staff College in Chennai that in order to claim, demand autonomy from the
government, and to enjoy that autonomy, the Reserve Bank must tender
accountability[ CITATION RBI13 \l 1033 ].
Author Ramesh S Arunachalam has emphasised that the time is now ripe to make the RBI
more accountable to the people of India. He reasons that with its wide ranging powers and
greater impact on all aspects of the economy, the accountability of RBI assumes even greater
importance and should not be ignored. He quoted RBI governor Dr. Subbarao “Neither the
RBI Act nor any rules lay down a formal accountability mechanism. In the absence of a
specific formulation, the fall back is on the general principle underlying a democracy—which
is to render accountability to the parliament through the Finance Minister” [ CITATION Ram13 \l
1033 ]

OBJECTIVES

The objectives of the study are:

1. To ascertain the degree of autonomy currently enjoyed by the Reserve Bank of India.
2. To deduce the need for autonomy of Reserve Bank of India for the economic growth
of India.
3. To determine whether and how autonomy could be granted to the Reserve Bank of
India.

RESEARCH METHODOLOGY

This paper is mainly descriptive in nature. It is an attempt to highlight the role of the reserve
bank of India as a regulator in development of the country and also deduce whether granting
autonomy to Reserve Bank of India can boost economic development of our country. Both
primary and secondary sources have been adopted for collecting the requisite information for
this study. The primary source comprise of interview method with the Reserve Bank of
India’s employees, commercial bank’s employees, state government employees, central
government employees and academician from related field, where the sample size is 25, i.e.
5 sample units from each category. The secondary data has been collected from books,
articles, news, internet, and mainly from working papers and archived data of the
International Monetary Fund for 10 selected economies.

DATA SET AND ANALYSES

SECONDARY DATA ANALYSIS

In the IMF working Paper titled “Measures of Central Bank Autonomy: Empirical Evidence
for OECD, Developing, and Emerging Market Economies” [ CITATION Mar06 \l 1033 ] prepared
by Marco Arnone, Bernard J. Laurens, and Jean-François Segalotto, the authors have
presented an updated version (2003) the GMT index (1991). The GMT index is an indicator
of central bank autonomy as defined by Vittorio Grilli, Donato Masciandaro, and Guido
Tabellini where autonomy is measured by building two simple additive legal measures-
political autonomy (autonomy in setting objectives) and economic autonomy (autonomy with
respect to instruments). Ten countries with various levels of autonomy scores have been
selected for our study.

For political autonomy, the central banks have been one point for each of the following eight
criteria if satisfied:

(i) the governor is appointed without government involvement

(ii) the governor is appointed for more than five years
(iii) the board of directors is appointed without government involvement
(iv) the board of directors is appointed for more than five years
(v) there is no mandatory participation of government representatives in the board
(vi) no government approval is required in formulating monetary policy
(vii) there are requirements in the charter forcing the central bank to pursue monetary
stability amongst its primary objectives
(viii) there are legal protections that strengthen the central bank’s position in the event
of a conflict with the government.

Table 1: Table showing Political Autonomy Index

COUNTRY APPOINTMENT RELATION CONSTITUTING POLITICAL

S WITH LAWS AUTONOM
THE GOVT Y INDEX
(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix)
FRANCE 1 1 1 1 1 1 1 1 8
GERMANY 1 1 1 1 1 1 1 1 8
UNITED 1 1 1 1 1 5
STATES
MEXICO 1 1 1 1 1 5
SRI LANKA 1 1 1 1 4
UNITED 1 1 1 3
KINGDOM
INDIA 1 1 2
NIGERIA 1 1 2
EGYPT 1 1
IRAN 0
Source: IMF working paper

The economic autonomy index is an indicator of autonomy in the selection of instruments,

and the central bank under examination gets one point for each of the following criteria if
satisfied:

(i) there is no automatic procedure for the government to obtain direct credit facilities
from the central bank
(ii) direct credit facilities to the government are extended at market interest rates
(iii) the credit is extended on a temporary basis
 (iv) and for a limited amount
(v) the central bank does not participate in the primary market for public debt
(vi) the central bank is responsible for setting the discount rate
(vii) the central bank has no responsibility for overseeing the banking sector (two
points) or shares this responsibility with other institutional entities (one point).

Table 2: Table showing Economic Autonomy Index

COUNTRY MONETARY FINANCING OF PUBLIC MONETARY ECONOMIC

DEFICITS INSTRUMENT AUTONOM
S Y INDEX
(i) (ii) (iii) (iv) (v) (vi) (vii) (viii)
FRANCE 1 1 1 1 1 2 7
GERMANY 1 1 1 1 1 1 6
UNITED 1 1 1 1 1 1 1 7
STATES
MEXICO 1 1 1 1 1 1 6
SRI LANKA 1 1 1 1 1 5
UNITED 1 1 1 1 1 1 2 8
KINGDOM
INDIA 1 1 1 1 1 5
NIGERIA 1 1 1 1 1 5
EGYPT 1 1 1 1 1 5
IRAN 1 1 1 1 1 1 6
Source: IMF working paper

Table 3: Table showing a consolidated index of both political autonomy score and economic
autonomy score of the selected 10 countries along with assigned rankings is as follows:

COUNTRY POLITICAL RANKIN ECONOMIC RANKIN

AUTONOMY G AUTONOMY G
SCORE SCORE
FRANCE 8 1 7 2
GERMANY 8 1 6 3
UNITED STATES 5 2 7 2
MEXICO 5 2 6 3
SRI LANKA 4 3 5 5
UNITED KINGDOM 3 4 8 1
INDIA 2 5 5 4
NIGERIA 2 5 5 4
EGYPT 1 6 5 4
IRAN 0 7 6 3
Source: IMF working paper

Now, the annual percentage growth rate of GDP (at market prices based on constant local
currency) over a period of 30 years at a 10 year interval for the selected 10 countries
arranged in descending order of political score autonomy is presented as follows.
(Aggregates are based on constant 2005 U.S. dollars)
 Table 4: GDP growth rate of Countries
(IN %)

COUNTRY 1980 1990 2000 2010 POLITICAL

AUTONOMY
SCORE
FRANCE 1.6 2.6 3.7 1.7 8
GERMANY 1.4 5.3 3.1 4.0 8
US -0.2 1.9 4.1 2.5 5
MEXICO 9.2 5.1 5.3 5.1 5
SRI LANKA 5.8 6.4 6.0 8.0 4
UK -2.2 0.8 4.4 1.7 3
INDIA 6.7 5.5 3.8 10.5 2
NIGERIA 4.2 12.8 5.3 7.8 2
EGYPT 10 5.7 5.4 5.1 1
IRAN -13.2 13.7 5.1 - 0
SOURCE: World Bank national accounts data, and OECD National Accounts data files

The data from above table has been plotted using a line chart with markers in two parts-

Figure 1: (France, Germany, US, Mexico and Sri Lanka)

10

6
FRANCE
4 GERMANY
US
2 MEXICO
SRI LANKA
0
1980 1990 2000 2010
-2

(Source: Table 4)
Figure 2: (UK, India, Nigeria, Egypt, Iran)
20

15

10
UK
5 INDIA
NIGERIA
0 EGYPT
1980 1990 2000 2010 IRAN
-5

-10

-15
(Source: Table 4)
Figure 1 contains the countries having higher political autonomy score while Figure 2
contains the countries having relatively lower political autonomy scores. The main objective
behind this data set and analyses is to find out the pattern of economic growth in the selected
countries. The stability in the growth pattern is to be attempted to deduce form this analysis.
Stability in economic growth can be seen when there is lesser variation in the growth degree.
Instability can be found for countries where there are wide fluctuations in growth. From the
above figures, it has been observed that countries having higher autonomy scores seem to
have more stability in the growth pattern while countries having lower autonomy scores are
seen to have relatively unstable economic growth pattern.

PRIMARY DATA ANALYSIS

Interviews conducted on individuals from related fields of a sample size 25 resulted in

majority of respondents inclined towards need for autonomy.

(i) 92% of respondents felt RBI is not autonomous, 8% were not sure and none could
positively assert that RBI is autonomous.
(ii) 96% of the respondents replied positively to the need for RBI autonomy. 4%
respondent felt autonomy to RBI could hamper the interests of general public.

Some selected excerpts from the interviews conducted are,

“The financial crisis of 2008 changed the attitude of governments across the world
towards autonomy of central bank economy. Even the biggest economies like England,
Japan and US tries to interfere their functioning by mainly making them finance the
Government spending. The Bank of Japan shed its autonomy by recently agreeing to buy
an unlimited number of government bonds to meet its 2 per cent inflation target.
Likewise, the U.S. Federal Reserve is buying more than 90 per cent of newly issued U.S.
Treasury securities. In India too RBI is often used by Govt. to ensure its social obligation,
like controlling inflation, financial inclusion and delivering of benefits to target groups.
And these guidelines are often influenced by the priorities of political party in govt.”
-A commercial bank employee.

“The role of central bank is crucial for every economy. RBI’s many roles in our country
may be hampering the economic development of our country in the long run. It is no
hidden fact that RBI has been seen having uneasy differences with the ministry of finance
in the past also. Therefore a feasible option would be to segregate the central banking
function from the government agency function. A central bank with sole focus on
economic development free from government obligations can definitely bring the much
needed economic reform in the true sense.” - A Public Sector Undertaking employee.

“The continuous and on-going consumer price inflation has induced us general citizens
to wonder whether the protectors of economic health of our country like RBI are working
for the country or are they too caught up protecting the health of our government. If
autonomy is ensured to RBI it will definitely lead to quicker decision-making and faster
implementation.” – A State government administrative employee.
 “Because of lack of autonomy the Reserve Bank of India is not able to take solid decision
to curb the unscrupulous activities, especially in the banking sector, which is hampering
the development of Indian financial sector. For example the commercial banks are
advancing loans to the customers who were earlier found guilty of non-repayment of
loans.” – A professor in the department of
Commerce, Gauhati University.

“Autonomy of RBI is a vague concept. We cannot assert that RBI’s autonomy is 100%
nor can we say RBI is enjoying low autonomy. It is true that the Finance Ministry
handles the Board appointments as well as all policy decisions are to be consulted with
Finance Ministry before final implementation. But the RBI itself conducts the data
analyses from various sectors and feed the information to the Governor, who in turn
consult Finance Ministry. The RBI is concerned with those factors which have
implications on the health of the economy.” – A Reserve
Bank of India employee

FINDINGS AND CONCLUSION

From the data analysis, it seems highly evident that a relationship exists between the level of
autonomy granted to RBI and stability in the economic development of the country. The
major findings are:-

1. The degree of autonomy enjoyed by RBI is questionable. India has been assigned a
score of 2 out of 8 in the political autonomy index in the IMF working Paper titled
“Measures of Central Bank Autonomy: Empirical Evidence for OECD, Developing,
and Emerging Market Economies” prepared by Marco Arnone, Bernard J. Laurens,
and Jean-François Segalotto. Many of the governors of RBI have been vocal about the
need for autonomy. International institutions like International Monetary Fund have
also voiced their support for the need of autonomy of Reserve Bank of India. As the
Fund pointed, the independence of the RBI is not enshrined in the law and there exists
some legal provisions that could seriously question the degree of autonomy of the
central bank.

2. Countries having high central bank autonomy are seen to have relatively stable
economic growth from its counterparts with lower autonomy score. This can be
attributed to the fact that central banks which are more prone to political influence
may encourage economic cycles, because politicians may be inclined to boost
economic activity at times of impending elections which can greatly deteriorate the
long term health of the economy and the country. Such lack of stability will certainly
not be beneficial to India’s vision of growth and development.

3. India’s rank for ease of doing business can also be improved with the autonomy of
Reserve Bank of India. Increased autonomy will ensure greater efficiency of RBI
 functions and it will boost the confidence of the investors on the Indian Financial
System.

4. Before granting autonomy to the Reserve Bank of India, it is very important to ensure
that the central bank is made accountable to minimize any misuse of power by the
parties involved. There should be proper provisions to ensure accountability and
which should effectively place the primary objectives of the central bank at the
foremost emphasis. Some of the provisions which could be implemented are
suggested below:

 The terms of Board members of RBI should be limited.

 Proper techniques of evaluating performance of board members must be
implemented.
 The board members of RBI should be barred from involving in significant
non-board activities.
 Adoption of an official formal code of conduct publicly.
 Adoption of a systematic, fast and transparent decision-making and
implementation process.

As per newspaper reports, for the year ended June 30, 2013, the Government of India has
received a bounty of Rs. 33,010 crore from the Reserve Bank of India, which represents the
surplus profit of the Reserve Bank of India [ CITATION RBI131 \l 1033 ] . This amount is likely to
be used by the Central Government to finance the fiscal deficit. But if Reserve Bank of India
is given the autonomy to utilise its surplus profit then such surplus profit could be allocated to
boost the development of the financial sector.

Further, a reference could be made of the Reserve Bank of New Zealand (central bank of
New Zealand)where a framework of accountable autonomy is practised wherein the governor
and his team are the primary decision-makers and the Board members exclusively engages in
a monitoring role of evaluating the performance of the central bank and the governor. The
autonomy of United States Federal Reserve (central bank of U.S.) is also mentionable since
its independence creates an obstacle for presidents interested in controlling macroeconomic
outcomes for electoral or partisan gain. Though it is true that none of these central banks
could be dismissed as completely free of government interference because over time reports
of such interference have also been encountered, but the level of accountability maintained by
these banks is also noteworthy.
REFERENCES

Arunachalam, R. S. (2013, October 31). How the RBI can be made more accountable.
Retrieved February 10, 2014, from www.moneylife.com:
http://www.moneylife.in/author/ramesh-s-arunachalam.html

Autonomy to RBI may tone up fiscal system. (n.d.). Retrieved February 9, 2014, from
www.financialexpress.com: www.financialexpress.co/news/-autonomy-to-rbi-may-tone-up-
fiscal-system’-/303797/

Doing Business 2014. (n.d.). Retrieved February 10, 2014, from www.doingbusiness.org:
http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-
reports/English/DB14-Full-Report.pdf

GDP growth (annual %). (n.d.). Retrieved February 5, 2014, from www.worldbank.org:
http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?page=4

Maheshwari, S. M. (2005). In S. M. Maheshwari, Banking law and practice. Kalyani

Publishers.

Marco Arnone, B. J.-F. (2006, October). IMF Working Paper. Retrieved February 5, 2014,
from www.imf.org: Jean-François Segalotto

Need to ensure autonomy to central banks. (2011, June 10). Retrieved February 10, 2014,
from www.businessworld.in: http://www.businessworld.in/news/finance/banking/need-to-
ensure-autonomy-to-central-banks:-rbi/310593/page-1.html

Need to tweak the law to ensure rbi autonomy -IMF. (n.d.). Retrieved February 10, 2014,
from www.thehindubusinessline.com: www.thehindubusinessline.com/industry-and-
economy/banking/need-to-tweak-the-law-to-ensure-rbi-autonomy-imf/article5086303

RBI must tender accountability to enjoy autonomy. (2013, July 3). Retrieved February 10,
2014, from www.hindustantimes.com: www.hindustantimes.com/business-
news/businessbankinginsurance/rbi-must-tender-accountability-to-enjoy-autonomy-
subbarao/article1-1086671.aspx

RBI transfers Rs 33,000 cr surplus to govt. (2013, August 8). Retrieved February 10, 2014,
from www.thehindubusinessline.com: For the year ended June 30, 2013, the Government of
India has received a bounty of Rs. 33,010 crore from the Reserve Bank of India, which
represents the surplus profit of the Reserve Bank of India

Reddy, D. Y. (n.d.). Autonomy of the Central Bank : Changing contours in India. Retrieved
February 8, 2014, from www.rbi.org: http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?
Id=88
Reserve Bank of India Act, 1934. (n.d.). Retrieved february 7, 2014, from www.rbi.org:
http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIA1934170510.pdf

Reserve Bank of India History. (n.d.). Retrieved February 5, 2014, from

www.rbi.org.in/History/Brief_Hiltonyoung.html