It is seen as an instrument of last resort, a direct order from the government of the day to the central bank to carry out its wishes.
The Modi government, despite its growing frustration with the Urjit Patel-led RBI, has resisted suggestions that it invoke Section 7 to increase liquidity, ease pressure on banks and businesses, and boost economic growth. But there are indications that via recent communications, it has initiated a consultative process with the RBI in three areas of concern and while doing so, has mentioned Section 7 without actually invoking it.
These areas are power sector loans, ‘prompt corrective action’ (PCA), and special dispensation for micro-small and medium enterprises (MSMEs).
Section 7 of RBI Act says, “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.”
The government’s move is significant as such a consultative process could potentially lead to the government issuing directions should the logjam persist.
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.
A senior official in the government said there has so far been no move to invoke Section 7. Another person, when asked, said, “Communication between the government and the central bank is sacrosanct and cannot be disclosed.”
There is some speculation that it was the government’s mention of section 7 that was the trigger for deputy governor Viral Acharya’s outburst against the government last Friday. While he did not make any reference to the Section, he did speak about how the government could undermine the independence of the central bank by ‘blocking or opposing rule-based central banking policies and favoring instead discretionary or joint decision making with direct government interventions’.
The government wants norms for non-performing assets in the power sector – which currently require companies to be referred to bankruptcy courts- to be relaxed. Once admitted, the companies have to be either sold or liquidated.
Its concern about ‘prompt corrective action’ is that the classification of PCA has placed lending and expansion curbs on 11 public sector and one private bank, which it believes is choking fund flows to several sectors. The government has also been worried about the fate of MSMEs, and is keen that the definition of bad loans be softened.
A broader concern is about the liquidity situation which has taken a turn for the worse after a series of defaults by IL&FS in September. The defaults have had a cascading impact — MFs that had invested in IL&FS debt were hit, corporates who had put shortterm funds in MFs turned cautious, and the funds themselves turned cautious about putting money in financial companies.