Central Bank Autonomy in India: The Delicate Balance of “the Elected” and “the Experts”

This article attempts to explore the legal, jurisprudential and policy aspects of Section 7 of the Reserve Bank of India Act, 1934 in the backdrop of the recent controversy surrounding the government’s proposal to issue directions to the Reserve Bank of India writes Ankur Sood.

The world is witnessing a gradual but perceptible shift in national attitudes towards the independence of their Central Banks. India is at the centre of the storm with not only public exchanges between the Government of India and the Reserve Bank of India (RBI), but the much debated decision of the Government to initiate the process under Section 7 of the Reserve Bank of India Act, 1934 (RBI Act) to issue directions to the RBI. Recently, the then Governor of the RBI – Dr. Urjit Patel – resigned in protest against the actions of the Government and a panel led by Mr. Bimal Jalan was appointed to frame guidelines for the transfer of RBI’s surplus funds to the Government – one of the main points of conflict between the Government and the RBI.¹ The fact that the provision has never been invoked till date makes the issue very interesting from the legal and economic policy standpoint. This article seeks to explore the legal, jurisprudential and policy aspects of the decision.

Historical Background

The proposal for establishment of a central bank for India, i.e. the RBI, was first made by the Royal Commission on Indian Currency and Finance (the Hilton-Young Commission) in 1926 and the legislation was initially introduced in January 1927.² The need for a central bank was re-emphasized by the Indian Central Banking Enquiry Committee, 1931.³ Prior to this the Imperial Bank of India (predecessor of the State Bank of India) functioned as a quasi-central bank.

RBI was established via the RBI Act and commenced its operations from April 1, 1935. Similar to the Federal Reserve Board of the United States of America, the RBI was initially a privately owned bank with its share capital owned by private shareholders. The justification for the establishment of the RBI was explained by Sir George Schuster, Finance Member, Legislative Assembly on 08.09.1933:

Some of the critical functions of the RBI include regulating the issue of notes, money supply, money maintenance, economic policy, monetary system, payments system and above all for regulating and controlling the banking system in India.⁵

Since the very beginning, maintaining the independence of the RBI from day to day political pressure and control was a focal point. However, the legislative intent was for a close co-operative working between the RBI and the Government. Towards this end, the following provisions were incorporated in the RBI Act:

• The Governor and the Deputy Governors were to be appointed by the Governor General in Council on the recommendations of the Central Board of Directors.⁶
• One of the Director’s on the Central Board was to be the Government’s representative⁷ and four Directors were to be nominated by the Governor General in Council.⁸
• The Governor General in Council also had power to remove the Governor, Deputy Governors and nominated or elected directors, subject to a resolution by an appropriate majority of the Central Board.⁹
• The Governor General in Council could also supersede the Central Board if, in his opinion, the Bank failed to carry out any of the obligations imposed on it and entrust the conduct of its affairs to an agency determined by him.¹⁰

The RBI Act, as originally enacted, did not contain a provision permitting the Government to issue directions to the RBI. The underlying concept was that while the direction of the RBI will be entrusted to people in whose judgment the Government has confidence, there will be no direct role or interference of the Government in the functioning of the RBI. The importance of the RBI’s functions and the standing required of its members has been duly appreciated by the Supreme Court of India with the following words:

After independence, the government passed the Reserve Bank (Transfer to Public Ownership) Act, 1948 and took over RBI from private shareholders. The appointment of the Governor and the Deputy Governors passed into the Government’s hands. The step was in line with the prevailing international trend towards nationalisation of central banks.¹² The proposal for nationalization of the RBI was based on the belief that the monetary organisation of the country should be a national concern and cannot be left in private hands.¹³

It was at this time that the proposal for a provision empowering the Government to issue directions to the RBI was mooted. The treatise History of the Reserve Bank of India (1935-51) discusses the proposal in the following terms:

The clause was drafted based on Section 4(1) of the Bank of England Act, 1946 and Section 9 of the Commonwealth Bank of Australia Act, 1945.¹⁵ Section 4(1) of the Bank of England Act, 1946 (as it stood at the time) read as follows:

Since then, two exceptions have been added in the Bank of England Act, 1946 curtailing the Government’s power to issue directions in relation to:

• monetary policy.
• the exercise by the Bank of its functions as the Prudential Regulation Authority.

Interestingly, the Commonwealth Bank of Australia Act, 1945 laid down a broad guideline for the central bank in exercise of its functions (Section 8) and also made a provision for specific policy directions by the Government (Section 9):

The RBI’s own proposal for Section 7 contemplated a provision similar to the Commonwealth Bank of Australia Act, 1945 with it being specifically clarified that when the Government decided to act against the advice of the RBI, they took the responsibility for the action. The Government was in favour of a provision closer to the Bank of England Act, 1946. Ultimately, the Government’s view prevailed and Section 7 was introduced into the RBI Act with effect from 01.01.1949.

Since its introduction, Sections 7(1) and 7(2) have stood unchanged and unused in the statute book.

The Economic Policy of Central Bank Independence

The long global history of central banks reveals that their independence has rarely enjoyed spells of unbroken consensus with regular fluctuation in thought on the subject.¹⁶ As long as central banks have been around, their power and independence from political interference has ebbed and flowed with the times.¹⁷ The principal rationale for making central banks independent was to enhance the credibility of inflation-targeting monetary policy, which became the standard approach to monetary policy after the demise of the gold standard and the following high inflation in the 1970s and early 1980s. The main argument has been summarised in the following words:

Importantly, a distinction has to be made between independence and accountability. The imperative for central bank independence does not mean that the banks are not accountable. Bruce K. MacLaury wrote in the context of the US Federal Reserve that:

Even an independent central bank, therefore, cannot remain completely divorced from the government’s policy goals and objectives, nor can it be unanswerable to any authority. The independence of central banks would only imply insulation from political interests – an independence within the government, rather than independence from the government.²⁰

There can be little quarrel over the fact that low inflation rates, stable economic growth and a non-toxic financial system are favourable conditions desired by central banks and any informed political class.²¹ The issues between governments and central banks usually revolve around a conflict regarding the best means of achieving these ends.²² Recently, there has been a growing consensus in the international community that central banks’ primary role has been to prevent or reduce inflation rather than stimulate it; they can restrain credit expansion but not the demand for it.²³

In today’s global scenario, many observers have asked whether central banks have exhausted the capacity of the ordinary and extraordinary policy tools they have deployed since the financial crisis.²⁴ Some of those observers even go on to say that central banks would be better equipped to counter the challenges in today’s economy if they worked in close collaboration with and under the control of a democratically legitimized government.²⁵ Some experts have even questioned whether in a democracy something as important as monetary policy can be kept outside the purview of the elected representatives of the people.²⁶ In a sense, perhaps the recent developments in India are an extension of the more globalised phenomenon of reduction of the belief in the complete independence of central banks.

Recent explorations of the unused: Section 7 of the RBI Act

The initial discussion around invoking Section 7 of the RBI Act was sparked initially by the judgment of the Allahabad High Court in Independent Power Producers Association of India v. Union of India²⁷ in writ petitions filed by power producers.²⁸ It was noted by the court that:

• Section 7(1) of the RBI Act empowers the Central Government to issue directions from time to time to the RBI as it may, after consultation with the Governor, consider necessary in the public interest.
• The Central Government, however, is not expected to issue any directions, as contemplated under Section 7(1), indiscriminately or randomly. Such directions are possible when there exists sufficient material in support.
• Where the two organs (the RBI and the Ministry) are at variance, the Government should consider whether the circumstances warrant the initiation of the consultative process. The purpose of Section 21 is to enable the Government to harmonise the competing views.

The judgment highlighted a conflict between the Government and the RBI and emphasised the need for harmonious resolution of the competing views.²⁹ The court opined that the purpose of Section 7 is to lay down a mechanism for the resolution of such conflict – a mechanism that perhaps gives primacy and final word to the Government, while keeping in mind the views of the RBI.

Soon after, in October-November 2018, news reports surfaced regarding the Government’s intention to issue directives under Section 7 of the RBI Act reportedly on as many as 12 issues, including:³⁰

• Easing the prompt corrective action framework of the RBI, i.e. the lending and other restrictions imposed by the RBI on particular banks to improve their financial health;
• Providing more credit to Micro, Small and Medium Enterprises;
• Improving liquidity to tide over the liquidity crunch being faced by NBFCs; and
• Transfer of some of RBI’s reserves to the Government in the form of dividend to reduce the fiscal deficit.³¹

There was an almost instant reaction from the RBI with Mr. Viral Acharya – a Deputy Governor of the RBI – issuing a strong statement during a speech on October 26, 2018³²:

He reportedly warned that undermining the autonomy and independence of the central bank could prove to be potentially catastrophic.³³ Mr. Acharya went on to compare the events to developments in Argentina in 2010, when the government in Argentina tried to force decisions on the central bank³⁴ – often seen as a contributing factor for the prevailing state of hyper-inflation in Argentina.

The Finance Minister, Mr. Arun Jaitley, responded by blaming the RBI for unmanageable figures of stressed assets by failing to check indiscriminate lending between 2008 and 2014 leading to the NPA crisis.³⁵

In this somewhat acrimonious climate, the Government moved forward by reportedly issuing letters for the initiation of the consultation process – a precursor to the issuance of directions under Section 7 – and by expanding the Central Board of Directors of the RBI.³⁶ The RBI’s response has come in the form of resignation of Mr. Urjit Patel – the RBI Governor.³⁷

Legal Analysis of Section 7

The ensuing battle between the Government and the RBI has raised important legal and policy issues, particularly: the scope of Section 7 of the RBI Act and the impact of issuing such unprecedented directions on the autonomy of the RBI.

To understand the meaning and purpose of the provision, it is helpful to begin with a bare reading of Section 7 of the RBI Act:

In express terms, the provision empowers the Government to issue directions in the public interest to the RBI. While Clause (1) does not explicitly lay down any consequences for violation of a direction, the effect of a direction issued by the Government is explained in Clause (2) – the powers of the Central Board of Directors to manage the affairs of the RBI would be subject to the directions issued by the Government. The manifest legislative intent appears to be that once any directions in terms of Section 7(1) have been issued by the Government, these directions would have to be complied with by the RBI.

Perhaps taking into account the importance of ensuring independence of the RBI (India’s Central Bank), Section 7(1) also prescribes multiple levels of checks and balances to prevent any misuse of the provision. First, the directions can only be issued in the public interest. Second, the directions can only be issued after consultation with the Governor of the RBI.

This position is similar to the provisions found in statutes governing other independent regulators established in India. In almost all the cases, the Government has reserved to itself an over-riding authority to issue directions to the regulator. Some of the statutory provisions empowering the Government to issue directions to independent regulators are set out below:

With regard to the aforementioned provisions, the courts have tended to recognize the Governments right to issue binding directions even where the statutory provision itself does not expressly provide for a binding effect. For instance, the University Grants Commission Act, 1956 only provides that the University Grants Commission would be “guided by” the directions, yet the Supreme Court held that the directions issued would have binding force.³⁸ Similar findings have been rendered in connection with the other provisions as well.³⁹ No doubt or question has been raised regarding the vires or legitimacy of these provisions.

However, a significant distinction between the RBI and other regulators is that unlike in other cases where specialized and expert knowledge was the raison d’etre, one of the major imperatives for the establishment of independent central banks has been the desirability of placing monetary policy outside the influence of political sentiments.⁴⁰ In case of central banks, unlike other regulators, independence from political interference and meddling is seen as an objective in itself in order to avoid propelling inflation.⁴¹

In this context, the difference in language between the RBI Act and the legislations governing other regulators is important. The RBI Act mandates “consultation” with the RBI Governor as a pre-condition for the issuance of directions, whereas the other legislations only provide the regulator to “express its views” before issuance of any directions. The language used in the RBI Act, while judicially untested, appears to give a stronger protection to the RBI against over-riding directions by mandating a consultation process, rather than merely an expression of views.

The term “consultation” has come up for judicial interpretation on a number of occasions with vastly differing views being expressed. In Union of India v. Sankalchand Himatlal Sheth⁴², the Supreme Court understood a “consultation” to be in the nature of an informed deliberation after all relevant information and facts have been made available to both parties.⁴³ In State of J&K v. A.K. Zakki⁴⁴, it was recognized that “consultation” does not mean concurrence, but it cannot be said to be complete till both sides make their points of view known to the other.⁴⁵ In Supreme Court Advocates on Record Association v. Union of India⁴⁶, “consultation” was understood as seeking opinion, advice, aid, information or instruction. Primacy was accorded to the voice of the consultee in the consultation process, i.e. the Chief Justice of India reflecting the collective voice of the judiciary.⁴⁷ The views expressed in Re: Special Reference No.1 of 1998⁴⁸ gave the widest possible ambit to the term “consultation” to mean not only consultation with the Chief Justice of India, but with a collegium of judges. The primacy of the judicial view was reiterated with the executive no longer holding a right to prevent a judicially chosen appointee.⁴⁹

Evidently, there does exist past precedent for treating a consultative process between high constitutional functionaries as more than a mere consultation with the political executive having an over-riding right. However, by and large, these formulations have been made in cases involving appointment and transfers of judicial officers and were justified on the anvil of the constitutional mandate of protecting the independence of the judiciary and the consistent past practice. The case in the context of the RBI is perhaps somewhat different since:

• There is no constitutional mandate for independence of the RBI. The independence of the central bank is merely a policy mandate with some statutory backing, albeit one that is considered very important for the economic health and well-being of the nation.
• There is no consistent past practice of giving supremacy to the RBI Governor’s view in the context of Section 7 of the RBI Act since Section 7 has never been invoked.

The linguistic formulation of Section 7 of the RBI Act indicates an apparent intention to ascertain the views of the RBI Governor before any steps are taken, while preserving the primacy of the Government view. This finds support from the historical context in which the provision was enacted.

Section 7 was introduced into the RBI Act with effect from 01.01.1949. The RBI proposed to impose an additional check on this power by requiring the Government to undertake that when it decided to act against the advice of the RBI, it took the responsibility for the action. This proposal was not accepted – perhaps because ultimately it is the Government that is answerable to the people and the nation – the provision was introduced giving the Government powers to issue specific directions that would be binding on the RBI.

Concluding Remarks: Achieving a fine balance

The supremacy of the elected government is one of the bedrocks of the modern democratic system. A democratic republic contemplates the rule of the masses based on a universal franchise. James Madison explained the formulation of democratic republics as a form of delegated power by the whole collective of the people to a small set of persons:

There has been a gradual transition from the rule of the monarch to the rule of the oligarch to the rule of the people.⁵³ Mr. Justice Padmanabhan has emphasized the importance of democracy as the source of all rights and liberties of the people:

The people, in a democracy, are the rulers – the sovereign – and the people themselves must determine the rules of governance. The democratic philosophy is that authority of the rulers is derived from the inherent right of the people to govern themselves.⁵⁵ In the Indian context, while there was some opposition to concepts of adult sufferage and rule of the people being incorporated in the Constitution of India, these principles were duly incorporated.⁵⁶ The members of the Constituent Assembly accepted that the government and the Constitution itself cannot but be anything other than the reflection of the will of the people:

Articles 325⁵⁸ and 326⁵⁹ of Constitution recognize the right of every adult to vote and, therefore, be duly represented in the governance of the nation. In terms of Article 74 of the Constitution, the executive functions are also placed in the hands of the elected Government of the day – formally, the Council of Ministers.⁶⁰ The elected Government acts as the representative of the people to define the rules of governance.

A part of the sovereignty delegated by the people onto their elected Government – relating to the monetary policy of the country – has been parted with in favour of the experts in the RBI. From the standpoint of both the legal and the economic policy framework, the power to direct monetary affairs of the country ultimately vests with the elected representatives of the people and it is perhaps for this reason that Section 7 was introduced in the RBI Act to permit the elected government – the true representative of the people – to issue directions to the RBI where it felt necessary.

However, as observed by the Allahabad High Court, the power under Section 7 is not untrammeled or unfettered - it cannot be exercised unreasonably or arbitrarily.⁶¹ Moreover, the directions can only be issued in the public interest and after consultation with the RBI Governor. The courts can step in to act as a check against governmental excess if any of these conditions are violated.

But perhaps, there is a more important and significant fetter on the Government’s exercise of its power – in the form of public debate that can shape the people’s will. An exercise of such extraordinary powers by the Government will always be a contentious affair and is bound to invite public debate and discussion. The debate and discussion ensures that both the competing views – the positives and the negatives of the specific issue as well as of merits or demerits of interfering with the independence of the central bank – will be brought forth and be placed before the people. In this scenario, in addition to the checks and balances already prescribed in Section 7, the public view and perception shaped through debate and discussion will ensure that the Government would tread carefully after giving due consideration. In essence, consistent with what was sought by the RBI at the time of introduction of Section 7 into the statute book, when the Government decides to direct the RBI, they take the political risk and responsibility for the action.