The ongoing heated debate on the ‘autonomy’ of the Reserve Bank seems to be marked by a lack of clarity on what is expected of the RBI. In keeping with the recent global trend, the RBI turned into an inflation-targeting entity. The moot question is whether this reorientation has led the RBI to overlook the shortfall in liquidity, at least within pockets of the financial system, at a time when NBFCs are badly in need of it. The Centre is within its rights to ask some questions on how the liquidity crisis can be urgently addressed, so that key sectors of the economy are not hurt. It is notable that M3 growth has fallen from 13-14 per cent in 2014 to below 10 per cent now, with a pronounced drop in the wake of demonetisation. At the same time, there has been a decline in capital inflows this year, accompanied by high levels of investment in US Treasuries. US Treasury holdings have increased from $100 billion in 2015 to $140 billion at present. The liquidity shortfall can be theoretically addressed through the following methods. First, the central bank can create money, an option that is considered to be decidedly inflationary and imprudent if it is leads to higher non-productive government spending. Second, it can reduce its Treasury holdings or raise overseas funds through ‘masala’ bonds. Third, the RBI can relax some of its stringent provisioning requirements so that banks with liquidity but constrained by the rules of the day can release them into the economy. If the Centre is pushing for the third, it should not be misinterpreted to imply that defaulters are being let off the hook. The Centre’s fiscally constrained in recapitalising banks, and seeking a solution. The onus rests with the RBI in finding a way out of the liquidity freeze, without going back on the NPA crackdown. It needs to work in tandem with the Centre in ensuring that growth is not destabilised.
If the autonomy of the RBI as the manager of the banking system needs to be respected, that has to be circumscribed within the economic goals set by the elected government. The Centre, while asking legitimate questions, should refrain from invoking desperate clauses or encroaching upon the management of payments and settlements systems.
The current impasse is also an occasion to revisit the inflation-targeting framework. The Bank of International Settlements has conceded that its successes are far from clear, with the developed world struggling to reach its inflation targets, even as asset price inflation tends to exist as a bubble in itself. In a developing world, where ‘full employment’ does not exist and inflation is a product of multiple factors, the pursuit of a single, immutable objective needs to be reviewed. A debate on how the central bank can, in tandem with the government, pursue multiple socio-economic goals needs to be foregrounded.