Business

India risks a high stakes fight with its central bank

Posted October 31, 2018 9:35 a.m. EDT

— Tensions between the Indian government and its central bank have spilled out into the open, raising fears that the country's fast-growing economy could be blown off course.

The Indian government said Wednesday that it would respect the autonomy of the Reserve Bank of India (RBI) after local media reported that the bank's governor, Urjit Patel, could resign in protest over political meddling.

"The autonomy for the central bank ... is an essential and accepted governance requirement," India's finance ministry said in a statement. "Governments in India have nurtured and respected this."

The statement followed reports that the government has invoked special powers within the RBI Act that allow it to issue directions to the bank — powers that have never been used before.

Prime Minister Narendra Modi has reportedly been leaning on the RBI to relax lending criteria and use excess funds to boost economic growth before national elections next year.

A spokesperson for the central bank did not immediately respond to a request for comment. But a senior RBI official — deputy governor Viral Acharya — used a speech last Friday to warn against government interference.

"The risks of undermining the central bank's independence are potentially catastrophic," Acharya said in a speech in Mumbai, citing Argentina's central bank crisis in 2010 as an example.

The dispute comes at tricky time for India's economy. Global growth is slowing, and India's currency has already fallen more than 15% against the US dollar this year, driven lower by fears that rising oil prices could push up inflation and higher US interest rates.

The rupee plunged again on Wednesday, dropping below 74 rupees against the dollar for the first time in two weeks. It recovered some of its losses after the finance ministry issued its statement.

Analysts warn that further escalating a fight with the RBI could raise inflation and hurt India's 8.2% economic growth, the fastest among major economies.

"A loss of credibility for the central bank could jeopardize its efforts to rein in inflation, which has been one of the big policy successes in India over the past few years," Shilan Shah, India economist at Capital Economics, wrote in a research note Friday. "The Indian government is treading on dangerous ground."

Another big emerging market, Turkey, showed the dangers of questioning central bank independence earlier this year. President Recep Tayyip Erdogan said in May that he wanted to take control of setting interest rates, which he described as the "mother and father of all evil." Less than two months later, Erdogan made his son-in-law finance minister.

Turkey's central bank then shocked the world by refusing to raise interest rates, despite soaring inflation, prompting investors to send the Turkish lira crashing. Turkey turned to Qatar for a $15 billion loan to shore up its finances.

The Turkish central bank on Wednesday projected that inflation would soar to 23.5% by the end of 2018.

The Indian government, meanwhile, defended its role in giving directions to the bank.

"Extensive consultations on several issues take place between the government and the RBI from time to time," the finance ministry said. "Both the government and the central bank, in their functioning, have to be guided by public interest and the requirements of the Indian economy."

This isn't the first time Modi's government has let disagreements with the central bank boil over into the open.

Patel's predecessor Raghuram Rajan, often referred to as India's "rock star" central banker, abruptly resigned in 2016 over tensions with the government.