What is Section 7 and how does it curb RBI's independence?

The public spat between the government and RBI has laid bare the perceived independence of India's central bank. To win the ongoing war of words, the Centre has invoked the most lethal weapon - Section 7 - in its armoury to browbeat the Reserve Bank. The RBI Act empowers the government to give directions to the central bank on matters of public interest.

Section 7

According to this section, the central government may from time to time give such directions to the RBI as it may, after consultation with the Governor of the Bank, consider necessary in the public interest. This implies that the government can invoke the Section 7 to get the central bank to take decisions on matters where it would otherwise be reluctant.

The government today said the functioning of central bank has to be "guided by public interest and the requirements of the Indian economy".  Although the government did not mention invoking Section 7 of the RBI Act but the usage of words 'public interest' in a press release issued by Finance Ministry points that the ongoing tussle between the two is far from over.

While the government and the RBI have had differences in the past, this is the first time in the Indian history when the executive has asserted itself by invoking Section 7.

The Section 7 of the RBI Act further states that "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."

In a way, the government-appointed Central Board of Directors have the last say. The RBI Act of 1934 doesn't give unconditional autonomy to the Reserve Bank and the buck stops with the Centre.

RBI vs Centre

The RBI and Centre have been at loggerheads for quite some time. The government wants the RBI to help ease the liquidity squeeze gripping non-banking finance companies (NBFCs) and relax the prompt corrective action (PCA) regime for NPA-laden banks.

The chasm between the two has been widening ever since RBI issued circular in February which directed banks to acknowledge every loan delayed beyond the 90th day as a non-performing asset (NPA) and provision for it. This alone raised India's NPAs by nearly 25 per cent to over Rs 10 lakh crore.

The turf war came out yet again when the RBI representative put out a dissent note to Inter-Ministerial Committee for finalisation of amendments to the Payment & Settlement Systems Act, 2007. The Committee recommended setting up an independent Payments Regulator outside the ambit of the RBI. RBI saw it as an attack on its powers and an attempt to shrink its authority over the banking space.

The Centre's move to introduce Project Sashakt during the brief tenure of Piyush Goyal as the finance minister in Jaitley's leave of absence didn't go down well with the RBI. 'Sashakt' gave a long rope to non-performing assets providing them between 90-180 additional days before they could be brought before the insolvency and bankruptcy process the RBI is pushing so aggressively. It was considered an extra-constitutional provision to resolve bad assets since the process of dealing with them is already well laid out.

Of late the two sides have also disagreed over the liquidity in the system. While the government believes RBI needs to infuse higher liquidity in the banking system to let NBFCs tide over an apparent financial crunch, the RBI believes there is enough liquidity in the system.

The trust deficit is evident in the unceremonious removal of Nachiket Mor from the board of RBI; surprise appointment of RSS ideologue S Gurumurthy to the board giving rise to allegations that Sangh may be infiltrating the regulator. Besides, the delay in filling the vacancies of the non-official directors (the 21-member board still has 3 vacancies).