Politics and Public credit: Looking through the Lens of the Reserve Bank of India

Typically developing countries are either struggling or just unwilling to distinguish their finances and politics. Due to insufficient control systems, central banks are prone to becoming used by governments for their own agenda.

The Economist has published an interesting article on the history of the Reserve Bank of India and summarized the challenges it has faced as a regulator.

The RBI grappled with its sense of purpose and became an almost subservient accomplice of political corruption. In 1997 and 2006 agreements were enacted to stop it being used as an ATM for the state. The magazine touted the RBI thereafter for its transformation into a normal central bank which readily addressed macroeconomic issues and even help India weathered relatively unscathed the 2008 financial crisis. Even though RBI’s independence is not enshrined in law, regulating officers expressed little concern about its independence in the latter part of the last decade.

However, the magazine pointed to emerging fears that the RBI has again fallen into the trap of becoming a lever of the state, this time for protecting India’s conservative political agenda. Banks today are still forced to invest 24% of their core assets into government bonds thereby pushing down the yield rate. As the Eurozone worries spread, the RBI has initiated a R14 billion bond-purchase program to guarantee low yields for state agencies.

India shares similar traits to pre crisis Greece. Both countries have pushed down public borrowing cost. Public credit in pre-crisis Greece was too cheap and government agencies were not carefully screened and assessed before they received a loan from the state; a state of affairs that exists in India today.

The Economist article on Reserve Bank of India can be accessed here.