Why invoking Section 7 is a risky affair

The use of Section 7 is fraught with risks to the autonomy of the central bank, the credibility of the government and the smooth functioning of the financial markets, says A K Bhattacharya.

A lot of heat and dust has been raised over Section 7 of the Reserve Bank of India (RBI) Act. Serious concerns have been raised over its use in the last few weeks.

Experts have also pointed out that even though the government has invoked Section 7 of the RBI Act to seek consultation with the RBI Governor, using it further to issue directions to the central bank will be damaging to the financial sector and to the credibility of the country’s apex bank and regulator.

Section 7 of the RBI Act allows the Union government to issue directions to the central bank from time to time if it considers them necessary in the public interest.

The important condition is that such directions can be issued after consultation with the RBI Governor.

Never in the past has any government sought recourse to this provision in the law.

It’s not that differences between the RBI and the government never arose in the past.

They did, but all those differences were resolved through consultations without seeking recourse to Section 7 of the RBI Act.

This is because using Section 7 is a risky path. Once the government begins consultations with the RBI Governor under Section 7, it is likely to become a one-way street.

If the Governor is not convinced of a certain course of action or policy earlier, why will he be convinced after the use of Section 7?

If consultation with the Governor is sought, then it is most likely that the government will be issuing a direction soon thereafter.

Only on the rarest of the rare occasion will the RBI Governor agree to bring himself round to the government’s line of thinking and obviate the need for a direction.

If that happens, there will be greater damage to the credibility and institutional integrity of the central bank.

Questions will be asked why the RBI had a different point of view before Section 7 was invoked for consultation and what prompted the shift in its stand.

This is also the reason why most RBI Governors in the past have avoided a situation where the government could come close to even seeking consultation with the central bank under Section 7.

If differences arose, and there were plenty of such instances, the RBI Governor and the finance minister or even the prime minister sat together or had a chat over the phone to sort them out.

In such consultations, the RBI Governor would explain his stance on the issue under debate and the government too could present its viewpoint.

In the end, the RBI would agree to toe the line suggested by the government.

There is also a possibility that the government after having used Section 7 to seek consultation with the RBI Governor retraces its steps on the ground that it has been convinced by the explanation offered by the central bank.

In such a situation, the government loses its credibility and critics are likely to say that the uncertainty caused to the financial markets was harmful and avoidable.

Either way, the use of Section 7 is fraught with risks to the autonomy of the central bank, the credibility of the government and the smooth functioning of the financial markets.

Which is also why this provision was never invoked in the past in spite of its remaining on the statute book for so many years.

But there is another aspect to Section 7.

Even though the government did not issue any direction under this provision in the past, it has nevertheless benefitted from it.

The mere existence of Section 7 on the statute book has been used by the government as an instrument to discreetly put pressure on the RBI to come to the table for consultation.

For governments, therefore, Section 7 has served its purpose very well.

This is quite ironical. A key reason for including Section 7 in the RBI Act was just the opposite - to make the government accountable if it were to impose its decision on the central bank.

According to Volume 1 of the History Of The Reserve Bank Of India (1935-1951), Section 7 was considered desirable “to make it clear in the Act itself that when the Government decided to act against the advice of the Governor, they took the responsibility for the action they wished to force on the Bank”.

In the past, on several occasions, the RBI was persuaded to do what the government wanted it to do, but the government never took responsibility for such action.

A case in point is the central bank’s regulatory forbearance during the rule of the United Progressive Alliance (UPA) that allowed banks to lend indiscriminately from 2008 to 2014 and suffer from the consequences of stressed assets.

The central bank’s worries over a rise in indiscriminate lending were set aside by a nudge from the government, which wanted to use those loans to fuel investments and growth.

The scenario would have been different if the RBI had put its foot down and told the UPA government that if it wished regulatory forbearance, it could use Section 7 to issue directions.

If that had been done, the markets would have been in turmoil, but at least the blame for regulatory forbearance wouldn’t have fallen on the central bank.

Has the time then come to recognise that the true purpose of Section 7 of the RBI Act should not be defeated?

Section 7 was actually framed to safeguard the RBI’s interests.

If the central bank believes that the policy being imposed on it by the government through consultation is not appropriate, it should let the government use Section 7 to send directions, so that the latter can take responsibility for its action and face the consequences.

Fears over using Section 7 are understandable.

But it is also true that invoking Section 7 can keep the RBI in the clear and if anything, it forces the government to take responsibility for the action it decides to force on the central bank.

Photograph: Francis Mascarenhas/Reuters