Government–RBI spat: What Section 7 of RBI Act means and why it was invoked

Publish Date: November 5, 2018

The Central Government and the Reserve Bank of India (RBI) have been at loggerheads for some time now. The government is allegedly peeved with the RBI’s apparent nonchalance in resolving the issues faced by public sector banks, including bad loans, and tweaking the Prompt Corrective Action (PCA) framework for better liquidity management.

Unable to have its way, the government finally invoked Section 7 of the RBI Act, 1934. This mandates the government to give directions to the central bank in public interest. In its 80 years of existence, the section has never before been used by any government.

Here is a look at what Section 7 of the RBI Act is all about and why it was invoked.

Decoding Section 7 of the RBI Act

The RBI was set up following the RBI Act, 1934. Since it was established under a separate act, the apex bank functions independently of the government. However, a provision under Section 7 of the Act says that in specific instances, the RBI has to take orders from the government in public interest.

Here is what Section 7 (1) of RBI Act says:

‘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.’

Section 7 (2) gives the government power to entrust the running of the RBI to its Central Board of Directors. Meanwhile, Section 7 (3) states that the deputy governor, in the absence of the governor, is entrusted with the power to give direction to the apex bank.

Why is the section invoked now?

No other government in India has ever used the powers of the section this far. The government even shied away from invoking the section during the economic turmoil of 2003 and in the run-up to economic liberalisation in 1991. This time, however, things came to such a pass that the apex bank did not budge from its stance despite repeated requests by the government.

Read: What is ailing Indian banks?

Bones of contention

• The government wanted the lending rules eased so that MSMEs (micro, small and medium enterprises) could gain easier access to capital. The RBI refused to oblige. It argued that such a step could be retrograde, and all efforts to clean up the bad loans of banks would go down the drain.
• Following the default of IL&FS in September, non-banking finance companies had urged the government to make the lending framework lenient. But the government claims that its request went unheeded.
• The government wants to set up a payment regulator that is independent of the RBI. This too has not gone down well with the apex bank.

Ramifications of the controversy

Invoking Section 7 of the RBI Act is perceived as a severe attempt to curb the autonomy of the country’s apex bank. Since the section had never been imposed earlier, it is unclear how things will pan out eventually. However, speculation is rife that by invoking its special power, the government has undermined a leading institution of the country. The spat is also likely to do more harm to investor confidence which has already taken a beating owing to a depreciating rupee and a widening current account deficit.

Read: Forget hiking rates, here’s how RBI has quietly tried to stem rupee slide

Conclusion

The country can ill afford such a controversy when bigger issues like a falling rupee and surging oil prices are hurting India’s economy. More importantly, if efforts are made to undermine the country’s banking regulator, it does not speak well about the state of affairs. Many experts feel that the sooner the RBI and the government resolve their differences the better it will be for the country’s economy.

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