RBI vs Govt: What is Section 7 and why has it taken centrestage

New Delhi, Oct 31: India has never invoked Section 7 of the Reserve Bank of India Act of 1934 in the central bank's 83-year history. There have been reports that the government may consider invoking Section 7 of the Reserve Bank of India (RBI) Act allowing it to issue directions to the central bank governor on matters of public interest.

The government has written to the RBI hinting it may invoke Section 7 of the Reserve Bank of India Act 1934 - a provision that has never been used since the inception of the law - to issue directions on relaxing prompt corrective action (PCA) norms, liquidity to non-banking financial companies (NBFCs), among others.

So, what does Section 7 of the RBI Act say?

Section 7 of the RBI Act empowers the government to issue directions to the RBI, after consultation with the Governor, on issues of public interest.

"The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public inter­est," Section 7(1) of the RBI Act reads.

The sub-section under Section 7 further reads, "Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a Central Board of Directors which may exercise all powers and do all acts and things which may be exercised or done by the Bank."

Section 7(3) reads,"Save as otherwise provided in regulations made by the Central Board, the Governor and in his absence the Deputy Governor nominated by him in this behalf, shall also have powers of general superintendence and direction of the affairs and the business of the Bank, and may exercise all powers and do all acts and things which may be exercised or done by the Bank."

However, complete implication of the section cannot be determined because it has never been invoked in the history of independent India.

Interestingly, the government did not invoke the section in the crises of 1991, 1997 and 2008.

The issue of invoking Section 7 first came up during a hearing before the Allahabad high court in a case filed by the Independent Power Producers challenging the RBI's February 12 circular, which did away with all restructuring schemes for loans in default. After the counsel for RBI pointed out that legally the government could issue directions to the central bank, the court in its ruling in August said such a move could be considered.

Historically, whenever governors have spoken about the independence of the central bank, they have never failed to point out that Section 7 has never been used.

Why has the government invoked Section 7?

The dispute between RBI and the government are at loggerheads for a few months now. It has come out in the open at a time when the economy currently the world's fastest-expanding major one -- is facing risks from elevated oil prices, a weak currency and a crisis in the shadow banking sector.

However, the regulator stood its ground arguing that such a move would put the clock back and undo clean-up efforts. With the credit markets tightening after the IL&FS default in September, non-banking finance companies lobbied the government for more liquidity. But RBI maintained its position since the banking system did not witness any spike in borrowing costs and the market was just repricing risk in an evolving situation.

Why is Section 7 seen as an extreme measure?

The aggressive move could scandalise a section of academia and experts, while raising questions about the government's intentions and the impact on RBI's autonomy.

Section 7 has two parts consultation and then issuing a direction to RBI for taking some action in public interest. Right now only consultations are on, which may or may not result in any direction being issued, sources said.

It is being speculated that RBI Governor Urjit Patel may choose to resign if a specific direction is issued to the central bank under Section 7. Former Finance Minister and senior Congress leader P Chidambaram warned of "more bad news" if indeed the government were to invoke Section 7 of the RBI Act.

If the move was indeed true, it showed that the government was 'desperate' and was hiding facts about the economy, he said adding the previous UPA government did not invoke Section 7 prior to liberalisation of the economy in 1991, the Asian financial crisis of 1997 or the period after the recession in 2008.

A speech made last week by Viral Acharya, the deputy governor of the RBI, which brought the tensions between the RBI and the government to the fore, might have been provoked by the government's invocation of Section 7. Stressing the importance of the central bank's autonomy, Acharya had sounded a warning to the government - keep your hands off the RBI.