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Frontal assault

30 March 2015 By Andy Mukherjee

India’s central bank is facing an assault on its authority. Powerful opponents in New Delhi want to set up a tribunal to second-guess the Reserve Bank of India’s decisions. They also want to hand over supervision of bond trading to the stock market watchdog. Undermining the monetary authority would be a mistake. Investors would rather live with a bossy RBI than a weak one.

The campaign to clip the RBI’s wings started gathering momentum after the publication of a controversial 2013 report by an advisory body set up by the finance ministry. The Financial Sector Legislative Reforms Commission (FSLRC) recommended that the central bank concentrate on setting monetary policy and regulating banks. Everything else – including the task of maintaining overall financial stability – would be taken away from it. Most significantly, the RBI would be subjected to a Financial Sector Appellate Tribunal which would, among other things, hear appeals against the central bank’s regulatory decisions.

That’s ominous. At present, the RBI can order a wayward lender to stop issuing new credit. If judges gain the power to reverse such decisions, India’s financial sector would be even more prone to political meddling than it already is. Oddly enough, the campaign to enfeeble the RBI is proceeding with little regard for the damage it might do to India’s international reputation. Governor Raghuram Rajan, who enjoys widespread respect, has publicly expressed his unhappiness over implementing the FSLRC report, including the notion of subjecting the RBI to judicial review.

Superficially, the idea sounds harmless, even fair: victims of regulatory overkill deserve a chance to seek redress. But in practice, an appellate body would be problematic.

To see why, consider the country’s stock market regulator, whose decisions are already subject to judicial review. The Securities and Exchange Board of India routinely loses important cases at the Securities Appellate Tribunal, especially when the watchdog tries to punish insider trading, or enforce truth-telling by companies when they raise money via public markets.

It’s possible that Sebi is exceeding its statutory powers, or that its lawyers are particularly bad at defending the regulator’s decisions. A more likely explanation is that proving financial wrongdoing requires a level of sophistication that’s hard for a resource-constrained regulator in a developing country to muster. Either way, a lot of bad behaviour is going unpunished.

By contrast, the RBI exercises unquestioned authority over lenders, payment systems and India’s half-closed capital account. Though its highhandedness is often infuriating, the 80-year-old institution has a reputation for integrity. In a country where corruption is still a big problem, and political interference plagues the state-dominated banking system, being an idiosyncratic but relatively honest institution matters more than the appearance of fairness and due process.

Shedding some of the central bank’s load would be genuine reform. For example, handing management of the government’s bond issuance programme to a separate body is uncontroversial. The RBI sets interest rates; it shouldn’t also be the government’s investment bank. Transferring supervision of government bond trading to Sebi makes little sense, though. The RBI’s order-matching system gives India a more liquid market than in most other Asian economies. Dismantling it would be folly.

Rajan’s international stature may not be enough to protect the RBI. One drawback is that he lent his name to some of the proposals he is now fighting while he was an economist at the University of Chicago. A committee he chaired in 2007 backed both a financial sector tribunal as well as the plan to strip the RBI of its power to regulate the bond market. Though the ideas weren’t Rajan’s, he didn’t denounce them either.

To be fair to Rajan, the financial crisis has upended the thinking about the responsibilities of central banks. The Bank of England, the European Central Bank and the U.S. Federal Reserve have become more powerful. Nevertheless, a few committed Indian conservatives still want to free their compatriots from what they see as a suffocating straitjacket imposed by the RBI.

They are on a dangerous mission. The central bank is the one Indian institution that investors trust. Its disempowerment could make them react badly. If they get the sense that Rajan might walk away rather than play along, the consequences could be worse. It’s still not too late for Prime Minister Narendra Modi to put the project to clip the RBI’s wings in the deep freeze. That’s where it belongs.




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