Friction fiction

May 15 2014, 20:40 IST
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SummaryWith most of the central bank’s and the Centre’s goals aligned, fears of the government impeding RBI’s independence seem misplaced

A subject that was never really important but became controversial recently is the issue of independence of the central bank. This brings up the question of what should ideally be the form of functioning of the central bank.

Central banks, all over, are owned by governments as they become the monetary arm of the government which ensures that ‘money’ performs the functions it is supposed to do. The fact that the government through one of its own arms owns the central banks does inherently imply a conflict of interest because the central bank has to finally be tuned to the owner. Counter-intuitively, if the central bank is not owned by the government, then who could possibly own the same? There cannot be any private party owning the currency as it affects both domestic and international payments. Thus, the ownership structure is unavoidable. This holds for all regulators, too, as the buck finally stops at the government.

That said, how should the central bank function then? There are two parts to this question. The first is the physical structure where all appointments are based on a government scale, which means that the recruitment process follows the same as in any public sector organisation, as do the pay structures and movement along the echelon. Some positions are directly appointed by the government through a set process. The other aspect is the functioning of the organisation which, prima facie, looks professional in the Indian context. This is, however, the area where the present controversy over independence emanates and the organisation structure per se has not really been part of the debate.

RBI performs five major functions that are critical from the point of view of the economy which go beyond printing currency. These are areas where the wisdom of being independent can be argued.

The first is acting as the facilitator of government debt. Here, there is an ongoing discussion over the extent of RBI’s support to the government’s borrowing programme. There are references made by RBI to keep this deficit under control. The government, on its part, has a fiscal programme which goes along the FRBM guidelines. Therefore, there are two responsible entities with differing views.

RBI has done away with the earlier custom of directly financing the deficit and all borrowings are through the market. In the earlier days, there was the concept of private placements wherein RBI took on the debt directly. Today, banks buy

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