Will invoking Section 7 mark a historic change in the Indian Money Market?

As the Centre invoked Section 7 of the RBI Act, this step just added more to the already-in-open conflict between the two authorities. While RBI stood tall to its autonomy status, the Government had no other way to reason but take such a step.

Section 7 RBI Act

By Apeksha Pandita in General Legal

Nov. 1, 2018, 3:22 p.m.

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While the media is flooded with the news of Section 7 of Reserve Bank of India (RBI) Act - 1934, many of you must be wondering what all is this fuss about?

Well, let me bring you up to pace.

As you know there has been a rift going on between the Central Government and the RBI. To cool down things, Minister of Finance and Corporate Affairs, Arun Jaitley issued a statement reiterating, “The autonomy of the monetary policy regulator is essentially within the framework of RBI Act.” 

However, the Government pointed out that there are consultations required to be given to RBI on various issues like easing the lending rules for banks under the Prompt Corrective Action (PCA) framework. 

On which, Union Finance Minister Arun Jaitley said while speaking at an event in New Delhi. “The central bank looked the other way when banks gave loans indiscriminately during the years 2008 to 2014.” He criticized RBI for failing to prevent lending excess in his speech.

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This is just one of the many important issues like the classification of non-performing assets (NPAs), setting up of a payments regulator independent of the RBI, among an entire list of disagreements between the government and the RBI.

The Government believes that steps like these could help in reducing the pressure on micro, small and medium enterprises (MSMEs). In response, the RBI has stood firm to its ground, arguing that such moves would undo all the clean-up efforts.

So, it can be said that the tensions between the Finance Ministry and RBI have been brewing pretty hot and increasing more & more, since the bank’s Deputy Governor, Viral Acharya said in a speech that Government seems to be undermining RBI’s independence, which could prove “potentially catastrophic”. 

Acharya had said last week, “A government’s horizon of decision-making is rendered short, like the duration of a T20 match, by several considerations”.

While an official of the Finance Ministry said last month, “Section 7 can be invoked only in exceptional circumstances and the power asset issue is too small to enforce Section 7 of RBI Act.” 

Well amidst this push & pull between the Government and RBI, the Government has finally initiated steps towards invoking its powers under Section 7 of the RBI Act of 1934. 

Section 7 is a provision in the RBI Act, which empowers the government to issue directions to RBI in public interest. However, this provision has been built into the law for governing regulatory bodies like RBI and in other sectors as well.

This adds a whole new twist in the rift between the Government and RBI. 

So, What is Section 7 of the RBI Act?

This Section was never used in India after Independence, until now. 
Even in the Balance of Payments Crisis of 1991 nor in the Global Financial Crisis of 2008, Section 7 never has come into implementation until recent events. Therefore, it’s not yet clear how this Section works.  

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Section 7 of the Reserve Bank of India Act - 1934, concerns with the Management. Under which the sub-section reads:

“(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. 

(2) Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a Central Board of Directors which may exercise all powers and do all acts and things which may be exercised or done by the Bank. 

(3) Save as otherwise provided in regulations made by the Central Board, the Governor and in his absence the Deputy Governor nominated by him in this behalf, shall also have powers of general superintendence and direction of the affairs and the business of the Bank, and may exercise all powers and do all acts and things which may be exercised or done by the Bank.”

Under this section, the government has exercised its powers and sent several letters to the RBI Governor, Urjit Patel in the recent weeks, addressing the issues of liquidity for non-banking financial companies (NBFCs), the capital requirement for weak banks and lending to MSMEs.

It can be presumed that such a step from the Government’s end has come into play after Viral Acharya warned the Government of terrible consequences if RBI’s autonomy is encroached on. 
However, this step could impact on Reserve Bank of India’s autonomy vastly. 

How does the Section 7 Work?

Knowing that Section 7 deals with the powers that the government has, where it can direct the RBI on policy issues. Here, the government initiates a dialogue with the central bank with a specific mention of the Act and lists the issues that it would like to discuss. 

After which, the law backs up the government, where it can give instructions to the central bank based the discussions between the two, which can help in easing out this quandary between the two sides, if they can cooly discuss all issues, and revoke the communications based on Section 7. 

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Why is Section 7 seen as an extreme measure?

Using the powers under Section 7 may be considered a sacrilegious step, among the central bankers, since it leaves little to no scope for the regulator to conduct the affairs in their own ways. 

On which, during a lecture in Mumbai Acharya said, As many parts of the world today await greater government respect for central bank independence, independent central bankers will remain undeterred,” 

Acharya added, “Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution; their wiser counterparts who invest in central bank independence will enjoy lower costs of borrowing, the love of international investors, and longer lifespans.” 

This shows nothing is going well between the Government and RBI clearly. Well, whether this step is going to be for the best or will it set a measure for future governments to push through their agenda, one can’t really put a finger on it!

However, the government has already started the process of invoking its powers under Section 7, which begins with starting consultations with the RBI Governor on issues of easing the PCA framework, providing more credit to small units and many more.

Former Union Finance Minister, P. Chidambaram added a new side to this the tussle, 

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This means the rift between the Government and RBI and its Governor Urjit Patel, which has widened from the start of this year has taken a tricky turn for the worse after Section 7 of the RBI Act has been invoked.

Well, what’s to observe here is that whether invoking Section 7 was really a needed step to change the Indian money market or is it another way of Government to cover-up something?

I let you be the judge of it. 

What do you think about it? Do let us know your views in the comments section below.
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