For long term interests of the economy, Central Banks across the world are designed to be insulated from the tumult of partisan politics. Macroeconomic stability cannot be left to the whims of people who rely on the electoral support of short-sighted masses to stay in power, and can artificially manipulate the interest rates out of line with the demands of the economic realities.
How independent is RBI from the government ?
Government controls the appointments
RBI is not completely free from the government. The Governor and Deputy Governors of the RBI are appointed by the Central Government, after their names are cleared by the Cabinet Committee on Appointments that consists of the Prime Minister and the Home Minister of India. But, after the appointment, the Governor of RBI is free from the government in his functioning. He has a secure tenure, that is fixed at the time of his appointment, and that allows him to take decisions independently. This tenure is typically set as 3 years; but cannot exceed five years at a time; reappointment is allowed.
Government nominated persons influence the decision on the benchmark interest rate
In the Monetary Policy Committee of the RBI, which consists of six members, three members are nominated by the government, and three are from the RBI – including the Governor of RBI. Since the casting vote in case of a tie rests with the RBI governor, the final balance of power in the MPC is still tilted towards the RBI. The government nominated persons just convey the concerns of the government to RBI and try to influence it.
Before the MPC was established in 2016, the RBI Governor alone decided the benchmark interest rate, with no role of government. There was a Technical Advisory Committee (TAC) which advised the RBI Governor, but the governor’s decision was final. With the establishment of the MPC, the government has increased its influence on the RBI, and reduced the discretionary powers in the hands of one person.
Section 7 of the RBI Act
The Section 7 of the RBI Act 1934 empowers the government to give directions to the RBI to take certain actions “in the public interest”. RBI and the government often differ over the interpretation of this provision.
Should the RBI be made more accountable to public representatives?
There is a debate over should the central bank be not accountable to public representatives. Many argue that making RBI completely independent from the government to the extent of breaking the line of accountability of the policymakers to the people would undermine democracy and run the risk of these technocratic bodies being captured by vested interests. Many suggest that RBI should be questioned by the Parliament, just as the US Federal Reserve is accountable to the Congress.
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Reserve Bank of India (RBI) – structure, functions, subsidiaries, related issues