Raghuram Rajan, former Reserve Bank of India (RBI) governor, said that said the central bank is like a seat belt, and without it, one could get into an accident. Speaking exclusively to CNBC-TV18, Rajan, who is now the Katherine Dusak Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business, said: "Once you have appointed a governor or deputy governor, you should listen to them." He commended RBI's deputy governor Viral Acharya for warning the government in support of RBI's autonomy.
Tensions between the finance ministry and the RBI have risen since Viral Acharya said in a speech recently that undermining a central bank's independence could be "potentially catastrophic", an indication that the regulator is pushing back hard against government pressure to relax its policies and reduce its powers.
Rajan, however, was of the view that the rift between the government and the central bank could be resolved if both sides respect each other's intent. He also pointed to the liberty that the RBI has where it can refuse to comply if the government pushes it to be lenient. He said the government could make its case to the bank and leave it to the latter to take a call on it.
The RBI board's objective is to protect the institute and not serve other interests, Rajan emphasised, adding, "Running over a central bank has not been good for any economy."
The RBI needs to examine the liquidity problem of non-banking finance companies (NBFCs) more closely and solve the issue by putting liquidity in the market, Rajan said.
The series of loan defaults by the Infrastructure and Leasing Financial Services (IL&FS) has resulted in doubts over financial soundness of the non-banking finance companies.
On Friday, the RBI allowed banks to provide partial credit enhancement (PCE) to bonds issued by NBFCs and housing finance companies registered with the RBI and housing finance companies (HFCs) registered with the National Housing Bank. This was aimed at enhancing credit rating of bonds and for NBFCs to get funds from the bond market on better terms.
NBFCs account for 17-18 percent of assets and currently, the problem is manageable, Rajan said, adding that the government can contemplate a bailout option if the liquidity problem persists in the NBFC companies. "In general, central banks avoid lending to direct entities. Lending to direct entities involves credit evaluation. Central banks are not in fiscal function of bailing out entities," Rajan said.
The country was in a much better situation in terms of inflations, said Rajan. He said the government and the RBI should be given credit for keeping inflation at lower levels. However, he raised concerns on the current account deficit (CAD) which has been increasing. The CAD widened to 2.4 percent of the GDP in the first quarter of 2018-19.
On central banks
Tightening of monetary policy will be witnessed across the world in the future, said Rajan, who was the former chief economist at the International Monetary Fund. During its October monetary policy review, RBI kept the key repo rate unchanged at 6.50 percent.
Regarding the US Federal Reserves rate hike, Rajan said the US has the benefit of a substantial fiscal stimulus. However, he said that the employment data would determine if the Fed could continue to hike rates.