A week before Diwali, both the Reserve Bank of India (RBI) and the Centre offered a good display of fireworks to the public by escalating issues that could have been kept off the public glare. But, lack of maturity and experience prevailed over impulsive actions and the regulator and the government chose to engage in the mudslinging fest out in the daylight.
Well, the good news is that things have stopped from escalating further with the government issuing a public statement clarifying on the issue. A glance at the markets tells us that the truce has been welcomed and calmed the investors. The government statement clearly acknowledges the need for RBI autonomy but within the framework of the RBI Act, by calling it "essential and accepted" in an economy.
But, not all is well here. There is an unmistakable sense of displeasure and warning from the government when it says that it frequently consults with RBI on important matters but never goes public with them.
This is a clear message to the RBI, particularly in the backdrop of deputy governor Viral Acharya's public outburst on RBI autonomy, that the organisation should not go public on differences with the government. The truce from the government has come. This, indeed, will be welcomed by the financial markets.
There was heavy speculation in the morning about the government invoking Section 7 of the RBI Act and the RBI governor, Urjit Patel offering to step down following this government move. Television channels appeared to have suffered an adrenalin shock pondering over the possibilities of an RBI versus government war. They also cited some recent communications. Some TV channels even flashed reports saying Section 7 has been invoked already. But unpleasant exchanges between the RBI and the government are not new. Also, everyone knows what Section 7 is. The question was whether this clause was pressed into action or not.
With the government leaving little to the imagination, now we know there aren't any immediate cause for worries. It is heartening that the government did not waste time to clarify the issue before sentiments took over trading terminals and markets went on a hysterical mode continuing from where they left during the recent IL&FS scare days. The government's statement has clearly helped to calm frayed nerves and bring some sanity to the financial markets.
In the world of financial markets, sentiments come at play first, then facts. Speculations can have major ramifications and destablise markets at least in the short-term , particularly equities. Mere speculation of a contagion of an IL&FS kind of crisis sent stocks of other well-run housing finance companies to multi-year lows. Again, it was speculations that the RBI won't support rupee, which sent the currency to all-time lows. Now with talk of Section 7 dominating the headlines, the government has done well refraining from escalating the issue further.
But, the show isn't over yet. Regardless of the truce, the spat between the government and the RBI is out in the open now. What will be the fate of contentious issues going ahead is a critical question. The points of disagreement are largely on the RBI's treatment of different sectors such as power as far as NPA recognition is concerned , the intensity of the prompt corrective action (PCA) imposed on at least a dozen state-run banks, the liquidity management in the financial system, rate actions and the control of payment systems (RBI recently issued a dissent note on this).
Ultimately, the buck stops with the elected government and not the RBI. This is the reason why the RBI Act makes the Central bank answerable to the government. For instance, section 7 is a powerful tool for the government to override the RBI. But, this work well in theory but is not so easy to implement in the real world. If the government openly invokes this section, it can cause much panic in financial markets. That's because the financial markets trusts the Central bank more than the political administrations. The Central bank know this, hence it often speaks up in public to influence the government.
In the Indian context, the timing is too bad for an RBI-government turf war. The economy has already taken a beating on account of the nosediving rupee, the NBFC default scare that has led to a liquidity squeeze in the financial system and the threat of global interest rates going up with US economy picking up steam and crude oil prices heading further north. It is important both for the RBI and the government to acknowledge the weakness in the economy and engage in more constructive consultations rather than using roadshows to deploy pressure tactics. The pain of hurt egos will linger for a while and cause a drag on the resolution of contentious issues.