Some commentators have invoked Section 7 (1) of RBI Act to suggest the RBI Board had no choice but to go ahead with the 8 Nov 2016 move.
Section 7 (1) says:
(1) The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.
Given one was trying to figure RBI Board History, I came across why this section came into being at the first place.
As argued earlier, RBI started as a shareholder bank with Board nomination coming from both Government and shareholders. However, while working towards RBI’s nationalisation the shareholder angle did not matter anymore. A Bill was prepared to amend RBI Act.
In the bill, on one of the points RBI Governor suggested that in case of differences between the two, the government should take responsibility for their action. However, Finance Ministry refused this and added what is now seen as Section 7 (1). From RBI’s First History Volume:
The clause relating to the giving of directions by the Central Government to the Bank was drafted by the Bank by combining the provisions of Section 4(1) of the Bank of England Act, 1946 and Section g of the Commonwealth Bank of Australia Act, 1945. The Governor considered it desirable to make it clear in the Act itself that when Government decided to act against the advice of the Governor, they took the responsibility for the action they wished to force on the Bank, although it was hoped that ‘occasions for the exercise of such powers will be few’.
The Finance Minister considered that the proviso as drafted by the Bank was not necessary and that it would suffice if a provision was made on the lines of Section 4 of the Bank of England Act; the relevant sub-section read as:
4(1) The Treasury may from time to time give such directions to the Bank as, after consultation with the Governor of the Bank, they think necessary in the public interest.
The clause thus provided for prior consultation with the Governor before issue of directives by the Treasury, but was silent as to the devolvement of responsibility, in the case of difference of opinion between the Treasury and the Bank. The prior consultation with the Governor would ensure that Government got the benefit of the Governor’s views on matters of importance to the country. The clause was redrafted accordingly.
Later, the second volume summed this:
While these provisions, other than those relating to the nomination of Central and Local Board members, have been in the statute book since the original Act was passed, section 7(1) of the Bank Act was amended at the time of nationalization in 1949 along the lines of section 4 of the Bank of England Act, to empower the central government to give ‘from time to time … such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest’. The Bank sought a more elaborate provision requiring the government to formally ‘accept responsibility’ for the action resulting from its directions, but yielded to the latter’s preference for the English precedent.
Wow. There is so much to learn and figure. How few additions and deletions in law matter so much.
So Government can give directions as one would expect but if there are differences between the two then the Act is silent on the devolution. As monetary matters come down to the central bank, whether there is a difference or there is similarity in the views between Fin Min and RBI, the blame will always be on latter.
Going to current times, we are seeing clear fallout of this change in RBI Act now. Even if RBI Governor expressed reservations, the blame game will be on their court. As some have said that the role of the government is to pass the decision and it was on RBI to implement the policy properly. Experts who pick this clause from RBI Act do not see the history behind addition of this clause. It was brilliant stratagem for the Government but leads to Catch 22 situation for the central bank. Either way it is doomed.
Above all, these episodes show how knowledge of law is so crucial to figuring central banking. It is not about inflation and growth alone…