New Delhi: Reserve Bank of India (RBI), Deputy Governor Viral Acharya pitched for ‘effective independence’ and asserted that governments that do not respect central bank’s independence would sooner or later incur the wrath of financial markets. “Undermining a central bank’s freedom could be ‘potentially catastrophic‘,” said Acharya while, delivering a hard-hitting speech in Mumbai. His statement comes amid instances of apparent differences between the government and the RBI.

Notably, the RBI and the government have been apparently differing on approach to certain issues, such as those pertaining to payment systems regulator and Prompt Corrective Action (PAC) norms for banks.  “Wiser politicians will give a central bank necessary autonomy so that they reap electoral benefits of stable macroeconomic conditions which such independence will bring,”PTI quoted Acharya as saying.

Furthermore he added,”What matters is the effective independence with which these powers (vested in the Acts governing the RBI or any central bank) can be exercised in practice. Governments that do not respect central bank’s 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.”

In his over 85-minute long speech, the academic-turned-central banker seemed to be expressing some satisfaction with the level of independence achieved by the RBI but underlined the need for more leeway, especially for regulating state-run banks where the RBI cannot effect any management changes, balance sheet management where fiscally pressured government eyes the surplus, and “regulatory scope” like its ongoing tussle on who manages the payments landscape with government.

Noting that markets have a keen eye on this aspect, he said that if uncertainty grows and confidence in central bank’s independence and credibility erodes, “then markets rap bond yields and exchange rate on the knuckles.”

“Wiser governments which accord the necessary leeway will benefit through lower costs of borrowing, the love of international investors and longer life spans,” he said.

He termed the RBI as a ‘friend’ of the government, which will “tell the government unpleasant but brutally honest truths and correct, to the extent it can, any adverse long-term consequences of government policies”.

Acharya cited global experience to point out that not maintaining independence of central banks has led to deep economic troubles as in Argentina in 2010 and also pointed out that issues faced by countries like Turkey have their roots in central bank’s independence.

Referring to the over Rs 10.50 lakh crore NPAs the banking system is plagued with, Acharya said,”Sweeping bank loan losses under the rug by compromising supervisory and regulatory standards can create a facade of financial stability in the short run, but inevitably cause the fragile deck of cards to fall in a heap at some point in future, likely with a greater taxpayer bill and loss of potential output.”

Notably, Acharya’s speech comes a week after the RBI decided to go public with its displeasure on who will regulate payment systems by posting a dissent note, and amid pressure from the government to relax the prompt corrective action (PCA) norms which restrict lenders’ activities for having high levels of dud assets and depleting capital reserves.

(With inputs from agencies)