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INTRODUCTION
India, the fastest growing major economy in the world with a population over 1.2 billion, had
become the hub for global investment. There were several factors which impacted and controlled
CASE ANALYSIS
the Indian economy. The RBI, India’s central bank and one of its oldest institutions, was one of the
factors behind the success of the Indian economy. The RBI, by printing new money and through the
monetary policy, monitored and influenced the movement of a series of macroeconomic indicators such
ON
as interest rates, inflation rate, money supply, and Gross Domestic Product (GDP). As the central bank of
the country, the RBI was one of the architects of the Indian economy and its decisions touched the
everyday lives GOVT –
of all Indians.RBI
From TIFF : IS stability
ensuring the THERE A MIDDLE
of interest ?
WAYrates to providing
rates and exchange
adequate liquidity for the productive sectors and ensuring an adequate supply of currency, the RBI also
monitored the flow of credit to the desired sectors and ensured the orderly development of financial
markets and institutions. Through a wide range of functions, the RBI contributed to nation-building.

Like the RBI, the government also played an important role in the development of the economy.
Since India had been an agro-based nation, the government in India had given utmost importance
to agricultural growth, adopting numerous measures including land reforms, introducing a new
tenancy system, giving economic subsidies, etc., for the growth of agricultural production. It had
also given equal importance to industrial growth. The government had provided credit facilities
and adequate subsidies to the industries to increase the scale of production. Basic industries like
defense, railway, power, and energy6 were under government control. Further, the government had
also emphasized the development of overhead capitals like energy, power, transport, communications,
education, health, housing, etc. It had also stressed the development of tertiary sectors like banking
finance, and insurance. Many foreign companies were By, setting up their facilities in India on account of
various government initiatives like Make in India and Digital India which Narendra Modi (Modi), Prime
Minister of India, had launched, TheAshwini
Make inSingh – 21BSP1192
India initiative aimed to give a boost to the manufacturing
sector of the Indian economy. The government also launched the Digital India initiatives that focused on
Ankita Singhania – 21BSP1186
three core components: the creation of digital infrastructure, delivering of services digitally, and
increasing digital literacy. Parth Saboo – 21BSP1220
On October 26, 2018, Viral Acharya (Viral), deputy governor of the Reserve Bank of India (RBI),
Sweta Singh – 21BSP1274
India’s central bank, brought a dispute between the RBI and the Indian government out into the
open when he made a fiery speech at the AD Shroff Memorial1 Lecture. Viral stated, “What
matters is the effective independence with which these powers (vested in the Acts governing the
RBI or any central bank) can be exercised in practice.” He added, “Governments that do not
respect central bank’s independence will sooner or later incur the wrath of financial markets, ignite
the economic fire and come to rue the day they undermined an important regulatory institution.”
The speech followed tough posturing by the government, warning that it would invoke the dreaded
Section 7 of the RBI Act under which it could hold consultation or issue directions to the RBI.
India had witnessed innumerable rows between the RBI and the government since the RBI was
established on April 1, 1935. Of these rows, the Raghuram Rajan-Arun Jaitley and the
Chidambaram-D Subbarao war of words had been the most prominent. However, the 2018 spat

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between Urjit Patel (Urjit), then governor of the RBI, Viral, and India’s finance minister Arun
Jaitley was unparalleled and it brought out into the open the fractured relationship between the
RBI and the government.
The row between Urjit and the government started within a month of his taking over as the RBI
governor when in November 2016, the prime minister demonetized the old INR 500 and INR 1000
notes. The RBI had to bear the brunt of the criticism against the botched and delayed execution of
re-monetization. However, the real blame game started with the $2 billion Punjab National Bank-
Nirav Modi scam3 with the RBI being blamed for being a sleepy regulator. But the action which
led to the actual spat was the RBI’s move to put curbs on lending by some weak state-run banks,
while the government, facing national elections in 2019, was keen on ensuring that the banks
continued to lend to boost economic growth. Transfer of surplus from the RBI to the government
was another contentious issue between the two. The RBI and the government also differed on their
approach to matters relating to the payment systems regulator and the Prompt Corrective Action
(PCA) norms for banks.
At the November 19, 2018 meeting of the board of directors, the RBI gave way to some of the
government’s demands. The RBI made concessions on the capital adequacy of banks, while two
contentious issues of transfer of surplus reserves and relaxing norms for weak banks were referred to
committees. Just when everybody thought that all was fine between the RBI and the government
after the November 19, 2018 board meeting, Urjit suddenly resigned as the governor of the RBI on
December 10, 2018, citing personal reasons.
Due to idiosyncratic historical reasons, the relationship between the central bank-government in
India had evolved very differently from that in other countries. The RBI Act, passed in 1934, aimed at
giving control of the central bank to the governor-general-in-council. After the nationalization of the RBI,
these powers naturally devolved on the Union government. Further, its control became tighter as Section
7 was amended in 1949, authorizing it to give such direction to the RBI as was necessary in the public
interest.

While the legal provisions favored the government, the economic logic for the de-facto autonomy
of the RBI was very strong. Avinash M Tripathi, associate research fellow (economics) at
Takshashila Institution, noted, “When the autonomy of the central bank erodes, we will be back to
the days of yore. Many decisions which seem technocratic today – say increasing the benchmark
interest rate for fighting inflation – will be subject to the heavy political slugfest and will have to
be adjusted to the electoral cycle. Ultimately, the monetary policy will become non-credible and
ineffective.” Amidst this backdrop, it remained to be seen how the government and the RBI would
resolve the problem of autonomy.

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 IDENTIFICATION OF PROBLEM
2018 Feud between RBI and Government

The tiff between the RBI and the government started off over issues such as exempting severely
indebted power companies from the February 2018 circular which identified them as bankrupt;
dilution of lending norms for a bunch of fiscally vulnerable public-sector banks to extend credit to
the cash-strapped small-scale sector; and, transfer of accumulated RBI reserves to the Union
government to bridge its fiscal deficit gap.
The RBI’s circular of February 12, 2018, asking banks to identify projects with even a day’s
default and chalk out a resolution plan within 180 days, a part of the Prompt Corrective Action
(PCA), became the flashpoint. The RBI order reclassified NPAs and set new norms for loan
restructuring. A new 180-day deadline was set for declaring a loan as an NPA. It said that after 180
days, the stressed account must go to the bankruptcy courts for settlement. As of mid-2018, 11 out
of 21 PSU banks were on the RBI watch-list. Two of them, Dena Bank and Allahabad Bank, were
also facing restrictions on expanding their business.
The RBI insisted on strict enforcement of the PCA, calling it a necessary step to protect the
banking sector from a crisis. However, the government considered the new regulations very harsh
as it left many of the public-sector banks in the red. The government also sought easing of lending
norms for the micro, small, and medium enterprises (MSMEs) sector. The MSME sector was the
biggest employment generating sector and contributed to about 40% of exports and about 45% to
the gross domestic product.

Further government moves to introduce Project Sashakt during the brief tenure of Piyush Goyal as
the finance minister during Arun Jaitley’s (Jaitley) leave of absence didn't go down well with the RBI.
Project Sashakt gave a long rope of 90-180 additional days to the banks before they had to bring the
NPAs before the insolvency and bankruptcy process the RBI was pushing so aggressively.

The Threat of Invocation of Section 7 and the Implications

While this tension was building up, a court order was issued allowing the government to consider
giving directions to the RBI under Section 7 of the RBI Act in a case related to independent power
producers. This instantly opened a way for the central government to get around the RBI’s opinion
and act according to their own wishes. Hence, on October 31, 2018, the government proposed to
invoke Section 7 of the RBI Act, which would enable it to issue orders to the RBI. Section 7 of the RBI
Act enabled the government to consult and give instructions to the governor to act on certain issues which
the government considered serious and in the public interest.

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 ANALYSIS AND LEARNING
OUTCOMES
On the issue of the government invoking Section 7 of the RBI Act, Rajan maintained it was best if each
side respected each other’s motivation and thoughts. “And ultimately the RBI after listening to the
government and hearing what the government’s issues were provided the best professional answer it
could and historically it has done that. I have no doubt it is doing that today. It has a responsibility to
fulfill to the nation. It has to listen of course but at the end of it, after listening it has to make a decision
because ultimately it has that responsibility,” stated Rajan. Former Union Minister of India P
Chidambaram (Chidambaram) tweeted, “If, as reported, Government has invoked Section 7 of the RBI
Act and issued unprecedented directions’ to the RBI, I am afraid there will be more bad news...”
Chidambaram also questioned the need to invoke the provisions of Section 7. “We did not invoke Section
7 in 1991 or 1997 or 2008 or 2013. What is the need to invoke the provision now? It shows that
government is hiding facts about the economy and is desperate,” posited Chidambaram.

Below are the reasons for invoking of section 7 of RBI act:

At the November 19, 2018 meeting of the board of directors, the RBI gave in to some of the
government’s demands. It made concessions on the capital adequacy of banks, while the two
contentious issues of transfer of surplus reserves and relaxing of norms for weak banks were
referred to committees.

Just when everyone thought that all was well between the RBI and the government after the
November 19, 2018 board meeting, Urjit abruptly resigned as governor of the RBI on December
10, 2018, citing personal reasons. Urjit’s resignation came against the backdrop of the growing tiff
between the Finance Ministry and the RBI. Rajan described Urjit’s resignation as a mark of protest. He
stated said that the government needed to understand what had prompted the resignation of Urjit.

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RBI is part of the government and has autonomy in three verticals – regulation of the banking
system, government's debt management and ensuring the low and stable inflation. The law is very clear; it
will have to work with the fiscal policymakers, which is the finance ministry. Globally, central banks and
governments have had different opinions on various issues, but that doesn't mean confrontation. Still, the
fact of the matter is that political expediency has scored. In getting the central bank to cede space on
operational matters – banking supervision, capital adequacy, forbearance, etc. – the government gets to
focus on its agenda of boosting growth in an election year without compromising on the fiscal deficit and
earning the ire of global ratings agencies It remained to be seen how the differences between the RBI
and the government would be resolved.

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