An independent RBI is a chimera-GS-3

Introduction

  • In recent months, the country has witnessed a raging debate on the independence of the central bank. It raises an important question: independence of whom, and independent of what? In literature, independence of a central bank has to be contextual, and has four main dimensions:
  1. Statutory independence from the state with respect to nomination, tenure and termination of the Governor.
  2. Independence of monetary policy instruments, implying managing of the interest rate or liquidity
  3. Independence of monetary policy objectives — inflation targeting, credit control, priority sector lending or any other objective which is stipulated by the government.
  4. Financing of government deficit

Roots of central bank autonomy

  • The concept of an independent central bank evolved in advanced economies and finds its roots in the successful anti-inflationary policy of Paul Volcker in the U.S. between 1979 and ‘82. The most independent central banks are those of Latvia, Hungary, Armenia, and Bosnia. India, Saudi Arabia, Singapore, and the U.S. are the countries with the least independent central banks.
  • The need is to recognise that there is a clear distinction in the functioning of central banks in advanced and emerging market economies (EMEs).
  • In advanced countries, financial markets are not only developed but seamlessly integrated, and financial institutions, established a long time ago, are mature, which ensures that the transmission mechanism is efficient. Therefore, central banks can focus on a single objective to be pursued by a single instrument, and hence the quick adoption of inflation targeting by many central banks.
  • Even in advanced economies, because of global spillovers, the challenge is of how to define independence of a central bank

In emerging economies

  • In EMEs, characterised by underdeveloped financial markets, with inefficient transmission mechanism and government ownership of financial institutions, independence could rather be harmful. In practice, central banks of EMEs have to pursue very diverse activities — diverse not only from advanced economies but also from other EMEs.
  • They have also to ensure that the financial system, including banks, is robust and stable. The government-owned banks lend extensively to other government-owned companies, compromising standard commercial viability criteria
  • The central banks of EMEs also have to focus on macroeconomic variables like capital inflows and balance of payments because most of them follow a managed exchange rate system. And simply to ensure that banking penetration is extensive, financial inclusion also becomes an important objective.
  • In a situation, globally, where the main objective of macro policy is GDP growth, financial stability, financial inclusion and trade-off between inflation and employment, then critically high coordination is necessary between different apex institutions, not independence.
  • Most importantly, in any democratic system, government institutions and government policies have to strike a compromising balance between diverse interests and be sensitive to the use of public resources. Seeking independence from the elected representatives is rather difficult in any democracy
  • In India, the objective of macro policy is enhancing economic welfare, and any one wing of macro policy, monetary or fiscal, cannot independently work without active support of another.

Source: The Hindu

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