India’s Fiscal Civil War

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The deputy governor of the reserve bank of India, Viral Acharya came out saying earlier this week that undermining the independence of the Indian central bank could be potentially catastrophic, in his own words. Understandably so, but what caused this threat and how is India reacting?

To be clear from the offset, the Indian reserve bank is not independent by statute. In fact, its governor is appointed by the Indian government, so even though as a bank it has experienced quite a comprehensive amount of autonomy in its regulation and control, there still remains a certain authority figure in the ruling government.

It is no secret that the Indian government and the central bank aren’t exactly on the friendliest of terms. Recently, these cold relations turned into outright conflict as both locked horns over several financial policies and prominently, who has control over the institution’s reserves. Currently the central bank transfers profits to the government in the form of some sort of dividend, but now the same government is calling to be allowed to dig into the bank’s estimated 43.76 Billion dollars’ worth of rupees.

In reaction to this, the president of the Reserve Bank threatened to offer his resignation, to which the Indian finance ministry responded by sending several letters threatening an invocation of a certain section 7 of the RBI act, handing over power to the government to dictate the bank’s policies. Clear was is the fact though, that the RBI is not taking to this situation lightly and has its mind set on fighting the government on the issue.

At this point, it really is a well-degraded lose-lose situation. The government has spent and is spending more than it can afford in order to try and gain the electorates’ favour just a few months before the coming general election, and now it wants to spend even more in public expenditure as it scrambles to stimulate the economy. While doing so, government revenues are in freefall as a result of not spending the money there was previously, which in turn meant that the currency would suffer, in this case, a fall of more than 15% against a strengthening US dollar.

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This situation could become worse still if the Bank’s chief offers his resignation as he said he might do, as this would further weaken investors trust in India, meaning that the same investors will start pulling their money out of India. And if that isn’t enough, one must know that all this is happening amidst a period of strong consumer spending and strengthened manufacture sector, so one can only imagine what the atmosphere would be like if these weren’t as such.

Written by: Gianluca Vella

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