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Finance ministry, RBI work out informal arrangement to avoid open clashes on policy issues
September, 13th 2013

The finance ministry and Reserve Bank of India have resolved to leave behind the rancour that marred ties during the tenure of former governor Duvvuri Subbarao with a broad agreement that aims to reset the relationship between the country's two most powerful policymaking arms.

The discussions between Raghuram Rajan, who took over from Subbarao on September 4, and the finance ministry were backed at the highest level of the government and took place before the former IMF chief economist assumed charge. Former RBI governors were also consulted.

The talks have resulted in an informal arrangement that clearly delineates the roles of the finance ministry and RBI, according to a senior government official involved in the discussions.

The government has agreed not to interfere in the central bank's management of monetary policy, particularly in setting short-term interest rates.

Further, North Block , as the finance ministry is referred to, will refrain from public expressions of disaffection such as those made in October last year following RBI's monetary policy announcement.

In an interview at the time, Finance Minister P Chidambaram told ET he was prepared to "walk alone" when it came to growth-friendly policies, referring to Subbarao's apparent reluctance to cut interest rates. Chidambaram aired this sentiment on several occasions during the former governor's tenure.

Under the terms of the informal framework, the finance ministry will have some say in financial sector reforms, although regulatory aspects will be RBI's domain.

However, the government, notably the finance ministry, will have a larger say in policy matters related to the development of the financial sector. This will encompass areas such as financial inclusion. Bank licensing will be entirely RBI's prerogative. On September 4, in the course of his now-celebrated inaugural press conference, Rajan unveiled an accelerated timeframe for new bank licences, setting a January 2014 target for issuing them.

"The idea is to have a framework on the road ahead to ensure close cooperation," said the senior government official cited above.

While the recent arrangement does not particularly break new ground — setting interest rates and bank regulation are already under RBI — the government official involved in the process said there was a need to fix the relationship as it had turned "really bad" in the last year of Subbarao's tenure. "Short-term interest rates and monetary policy management have to be strictly within RBI's domain, but financial inclusion agenda is clearly part of the government's political mandate," the official said.

This newfound coordination was reflected in the package of measures announced by Rajan at his press briefing.

For example, a more attractive version of the FCNR(B) scheme, intended to entice NRIs to deposit their dollars in Indian banks, was expeditiously cleared by North Block hours before the news conference to ensure Rajan could announce it in the evening.

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