DMPQ-Discuss the importance of independent institutions with special mention of independence of reserve bank of India.

Separation of power ensures efficient functioning of key organs of government as no individual organization can garner political monopoly and abuse power.

The RBI is not constitutionally independent, as the 1934 Act governing its operation gives the government power to direct it. The government appoints the central bank governor and four deputies.

Independence of RBI

  • Central banks mainly focus on long-term financial stability and growth. While the government/party in power has short-term growth as their prime focus, since they will be facing elections around the year, be it the central or the states.
  • Central banks strive to build credibility through series of difficult choices that reflect sacrificing short-term gains for long-term outcomes such as financial or price stability, which may not be in the liking of the government.
  • Most of the domain that is managed by RBI have potential front-loaded benefits for the economy, but the tail risk in form of financial instability.
  • Reducing the repo/policy rate will decrease the interest rate in the economy and thereby expanding the money supply. However, it may lead to inflationary pressures in the economy.
  • Allowing unlimited foreign capital into the economy can increase Foreign Portfolio Investment (FPIs) in G-Sec and corporate bonds. However, it can cause depreciation of the rupee and volatility in the market when these FPIs reverse. Eg: taper tantrum in 2013.
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