How free is RBI? Reddy touches raw Govt nerve

At a time when the government is battling double-digit inflation, a powering down of the growth momentum partly due to higher interest rates...

At a time when the government is battling double-digit inflation, a powering down of the growth momentum partly due to higher interest rates, Reserve Bank of India RBI Governor Y V Reddy touched upon a sensitive aspect of India8217;s political economy 8212; autonomy and independence of the central bank 8212; saying that the finance ministry does give signals, if not directions, on monetary policy, a domain strictly of the RBI.

Addressing a galaxy of central bank governors yesterday at the 7th Bank for International Settlements Annual Conference in Luzern, Switzerland, Reddy, whose tenure is scheduled to expire on September 6, said, 8220;It is quite possible that there are communications or signals, if not directions, from the Ministry of Finance often on issues relating to monetary policy, or banking, a sector predominantly government owned.8221;

Typical of Reddy, he stopped at that, without elaborating if such signals made his job as a central banker difficult.

Elaborating on the outcome of the finance ministry8217;s signals, Reddy said, 8220;If these are consistent with those of the central bank, they reinforce the central bank policies.8221; But if these were divergent, it posed a dilemma for central bank communication and to that extent a central bank might be constrained in freely articulating its policies, he added.

In his remarks on 8220;The virtues and vices of talking about monetary policy,8221; Reddy said, the RBI, through its actions, had acquired enhanced independence, though officially there was no noticeable movement in it getting greater freedom. 8220;My personal feeling is that improved communication in regard to the thinking and actions of the RBI has enhanced the de facto central bank independence, while, de jure, there has not been any noticeable movement in according greater independence.8221;

Reddy8217;s remarks come just days after RBI raised interest rates as inflation touched its 13-year high.

A day after last week8217;s inflation figures were released, Finance Secretary D Subbarao, the top bureaucrat in the finance ministry had clearly put the ball in the RBI8217;s court. 8220;The first line of defense is monetary policy action,8221; he said.

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Refusing to specify what measures the RBI could take, Subbarao said, the central bank was an independent regulator and it would know best. But, many present, did not miss the chuckle on his face.

Within the next three days, the RBI used its two most harsh instruments 8212; the cash reserve ratio the percentage of funds banks have to keep with the RBI and the bank rate the rate at which the RBI lends to banks, by 50 basis points each.

This dissonance between the government and the RBI does not go unnoticed by financial market participants. Says Rupa Nisture, chief economist, Bank of Baroda, 8220;While the RBI pursues a tight monetary stance, the government asks banks to hold their rates to keep the growth momentum on. Naturally, the RBI8217;s move to hike repo rate has not translated into an increase in the long-term rates of banks.8221;