RBI: What does it do and why should you care?

We have all heard of the Reserve Bank of India or the RBI and even seen the RBI governor’s signature on all our currency, but do we know what it actually does? Often when we hear of the RBI in the news, there are references to terms like repo rate, reverse repo rate, foreign exchange reserves and so on, and the fact that the RBI controls the health of India’s economy and it’s cashflow.

This episode simplifies and demystifies one of the most important Indian institutions — The RBI.

Show Notes

All clips and voices used in this podcast are owned by the original creators

Links to clips used in this episode —

• India’s Forex Reserves and Economy – Rajya Sabha TV – https://www.youtube.com/watch?v=D4x-qk76LiY

Full Transcript of Episode 12

[We hear the voices of several news anchors talking about the RBI]

We have all heard of the Reserve Bank of India ya RBI, but if I were to ask you if you know what it actually does, what would you say?  

Even former RBI governor D Subbarao had felt that it is necessary to demystify the Reserve Bank of India. In his book, ‘Who Moved My Interest Rate?: Leading the Reserve Bank of India Through Five Turbulent Years’, he wrote that a large majority of people, even educated Indians, do not know very much about what the Reserve Bank does. 

He wrote that many know that the RBI prints currency but beyond that, the Reserve Bank is a black box — a mysterious institution doing obscure things that have no real relevance for the people. So it is necessary to explain what the RBI actually does.

Chaliye, in our own way, let’s make an attempt to do that.

Almost every country in the world has a central bank and the RBI is India’s Central Bank.

So what does a Central Bank actually do? 

Many things!

The RBI creates money, of course. That is the first thing. The RBI also makes sure that money travels from place to place, account to account and bank to bank across India smoothly. 

Every time you buy something with a debit card at a shop or even the internet, an amazing number of transactions take place behind the scenes to make sure that money travels from your bank account to the account of the shopkeeper or the e-commerce website. It is the RBI that makes sure all those transactions take place quickly, safely and reliably. 

The RBI is also in-charge of making sure that banks function properly. 

Friends, most of us don’t even think twice when we open a bank account, or deposit money in our banks. We just trust our money to be safe in the bank’s custody. And we can do that only because of the RBI. 

And finally, and perhaps most importantly, it is the RBI that decides interest rates. If your Fixed Deposit is making less interest than before, or your house loan has become more expensive than before, then that is probably due to the RBI changing interest rates.

But this is just one way of looking at the RBI’s job. 

If you read textbooks or look at investment websites you will probably see a long list of Central Bank responsibilities. There is a second, somewhat simpler way of looking at the RBI’s job. And much of what you will hear in this episode makes more sense if you think of it in this simpler way. 

The RBI’s job is to manage the flow of money in a country. So imagine a huge tap out of which Indian rupees flow into the Indian economy. It is the RBI’s job to decide when to open the tap, how long to keep it open for, and then when to close the tap, and then how long to keep that tap closed. 

So now you’re probably thinking — How does the RBI increase or decrease money flow? And why would you want to decrease the flow of money at all. Arrey! Just keep the tap open and everyone is a crorepati? 

Not quite. Let’s find out about all of this:

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Let’s begin with RBI’s banking functions: RBI is the bank that the state and central government in India depend on. This means that RBI carries out all their banking duties — the government deposits its cash balances. RBI also accepts receipts and makes payment on behalf of the government. 

RBI also gives loans to the government for a temporary period whenever required. Like in the case of the Coronavirus, when many state governments fell short of money because of the lockdown. RBI gave them a temporary loan which they have to eventually pay back of course.

RBI also helps in managing the public debt of the country (desh ka karj ko chukaane ke liye.) Often the central government borrows money from international funding agencies like the World Bank, IMF etc to complete big projects in India. So what the RBI does is help in managing that loan (chukaane mein aur advise karne mein). 

RBI is also a banker’s bank (Can be said in English).

So just like the RBI carries out the banking functions (banking ka kaam) of the government, it does the same for the banks in our country.

When do you generally go to a bank? Often, it is when you’re short of cash and need it in an emergency. What if the banks themselves run out of money? Where can they go? To the RBI. 

You could ask: How does all of this affect you?

The point is simple — if your bank is affected, you will be affected. Which is why it is important for someone to regulate the banking system in India (banking system pe nazar rakhna). And that job is done by the RBI. 

Ek banker’s bank hone ke naate, the RBI makes sure that commercial banks do not misuse a depositor’s money. 

How’s that?

One of the ways (ek tareeka) is through the Cash Reserve Ratio. According to this, every bank is supposed to deposit a percentage of its deposits with the RBI. This is usually between 3 and 5 percent. Yaani, every bank has to keep 5% of all the money they have with the RBI. And the banks get no interest on this money.

So, even if banks run out of cash, then RBI can help depositors like you and me and ensure that our money is safe.

Now, when a bank misuses your funds, the RBI can also take action to help you, the depositor out.

Like in the case of the PMC bank. In 2019, yeh saamne aaya ki the bank had given loans of over Rs 6,500 crore to a real estate company which turned out to be a fraud company.

Depositors of PMC bank were obviously worried and that’s when this happened —

[We hear a news report about assurance from the RBI]

RBI protected the existing deposits — and put restrictions on the bank. It also raised the withdrawal limit — while the scam was being investigated.

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RBI ke zimmedari yeh bhi hai ki it maintains a foreign exchange reserve. Why is this reserve necessary? One reason is to pay for imports. Forex reserve is also important in the time of an economic crisis.

Jaise ki abhi, thanks to Covid-19.

[We hear a news report from NEWSx]

Yeh hai NEWSx ki report which tells us that RBI recently assured (bharosa dilaya) the country that it has enough forex to fight off the economic crisis (aarthik musibat ka saamna karne ke liye) brought on by COVID-19.

Waise, in June 2020, India hit a milestone:

[We hear the voice of Frank Pereira]

This was Rajya Sabha TV’s Frank Pereira telling us that in June India’s forex reserves crossed 500 billion dollars!

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Now let’s talk about RBI’s basic duty: that is controlling the supply of money in the economy. The question I asked you at the start of the episode is why control the supply of money at all? Right?

Because if you don’t, then this happens 

[We hear news reports about inflation]

Too much inflation ya mehengai is a problem nobody wants to have. And generally, inflation means that there is excessive supply of money in the market. So, one of the ways in which RBI attempts to resolve this situation is through its monetary policy and repo rate.

Kya hai yeh repo rate?

Like I told you before, RBI lends money to commercial banks. Like any loan, this loan too is given at an interest. And it is this rate of interest that is called the repo (रीपो) rate or the repurchase rate. 

If the repo rate is high, then it means a higher interest rate on the loan that the RBI gives to the bank. Similarly, a lower repo rate leads to a lower interest rate. 

Now, during an inflation, there is excess supply of money in the market. Basically, people are forced to spend more money for the same goods. 

In this situation, the RBI hikes up the repo rate. This discourages banks from borrowing money from the RBI (bank RBI se udhaar lene se hichkichate hai). Aur isi ke karan, the banks don’t give loans to people, too.

As a result, the circulation of money in the market reduces. And dheere dheere, prices come down.

For instance, in 2013, the inflation in India hit 9.13%. To give you a reference, the average inflation rate of India has been 6.01% from 2012 to 2020. Policymakers believe that around 2% inflation rate is healthy. So, 9.13% was a concern (chinta ki baat) for the economy. The RBI drafted a monetary policy to battle this hike in inflation (mehangai se ladne ke liye). 

In September and October of 2013, the then RBI governor Raghuran Rajan announced the hike in repo rate from 7.25% to 7.5%.  A gradual decline in the inflation rate was seen in the following year.

Sometimes, using the same repo rate, the RBI can also help in boosting the growth in the economy. The principle is simple: reduce repo rate, so banks feel like borrowing more money, which means they lend more money and which means people spend more and that ends up boosting growth.

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Now, there is another reason the RBI manages the supply of the money in the economy — And you must have heard about this on the news: the Indian rupee’s strength or weakness against the American dollar. Did you know that the RBI plays a big role in deciding this? 

But first: why does it matter? 

This thought must have crossed your mind at some point — why can’t the RBI just make 1 Rupee equal to 1 dollar? Won’t that make everything simple? It’s not that simple.

In fact the RBI plays a very delicate balancing act when it comes to the exchange rate. A weak rupee might not seem great but the fact is that a weak rupee often helps exporters who sell their goods to foreign countries. 

Imagine you are selling a shirt to Walmart for 10 dollars. When the exchange rate is 50 rupees to a dollar, you are making 500 rupees per shirt. But if the rupee weakens and becomes 55 rupees to a dollar, suddenly you are making 550 rupees per shirt. And if inflation in India remains flat, you are suddenly making more money than before thanks to the exchange rate.

On the other hand, imagine you are an importer who buys something from abroad. Maybe you import mobile phones from the US and sell them in Mumbai. For you, a stronger rupee is great. Because you get more dollars for the same amount of rupees. And that means you can import more phones, or the same number of phones for fewer rupees. 

This means the RBI has to manage exchange rates carefully. Make the rupee too strong and exporters start complaining, make it too weak and importers start to complain. 

But how does the RBI manage this? As always things are complicated and interconnected. But the easiest way to do this is for the RBI to use its Foreign Exchange reserves, i.e. the huge amounts of dollars that the RBI carries in stock. So if it needs to strengthen the rupee, the RBI will simply sell these dollars in the market and collect rupees. Which automatically reduces the number of rupees in circulation and increases the value of each rupee. And it does the exact opposite when it wants to weaken the rupee, it simply spends rupees and buys dollars. 

Once again the RBI uses the flow of rupees to manage an important aspect of the Indian economy. So next time you hear someone scream about how humiliating the weak rupee is, or how proud they feel about a strong rupee, just smile and let it go. The truth is much more complicated. Sometimes a weak rupee can build a strong India.

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Now, the RBI so far seems to be playing both the role of a doctor as well as a police in our economy. And it seems like its authority is unquestionable, right?

But often you would have also heard of tension between the RBI and the government.

[We hear news reports about the conflicts between RBI and the government]

Unfortunately, this is an old story and has been happening since the formation of the RBI back in 1935. 

In 1936 — The first Governor of RBI, Osborne Arkell Smith (ओसबोर्न अर्केल स्मिथ) resigned because of a difference in opinion between him and the then finance minister, James Grigg. This happened in Nehru’s regime, when the RBI Governor, Benegal Rama Rao stepped down. Aise hi, Urjit Patel also resigned during PM Modi’s term. The question is, why does this happen?

When it was formed in 1935, the RBI was thought of as an institution that will be independent from the government and will look after the country’s banking system and economy. Logic ye tha, that an independent organization that is free of political influence, can help with ensuring stability in the economy. Varna, if the government itself was to do what the RBI does, after every election, we’d have a crisis.

But, practically dekha jaaye toh often the government and the RBI — since they are both responsible for the economy — end up disagreeing on important financial decisions. For example, in 2018, the Central Government was unhappy with the RBI. Kyun? Because it didn’t cut down interest rates during inflation. At that time, the RBI governor was Urijit Patel.

Instead, the RBI actually increased interest rates. This disagreement led to a lot of problems between the two parties throughout the year. In the end Urjit Patel resigned at the end of the year.

Aisa hi kuch takraar was seen between the government and Raghuram Rajan. Raghuram Rajan was the first RBI Governor in two decades to not get a second term.

There has always some tension between the two parties – but the independence of the RBI is extremely important. This principle of independence is also shown in the emblem of the RBI.

You can find it on your rupee note. The emblem has a tiger standing in front of a palm tree. This emblem is derived from the East India Company emblem, which has a lion and a palm tree. 

India replaced the lion with a tiger, because it is a symbol of Indianness. Tiger also stands for independence . Toh meaning yeh bana ki RBI governmental body hai par government se independent bhi hai.

The palm tree represents truth, warmth, protection and singleness of purpose (taad ka ped sacchai, suraksha, josh aur uddesh darshata tha). 

Anyway, that’s it from me in this episode. Hope I have helped demystify RBI to some extent for all of you. I’ll be back next week, with yet another episode of Maha Bharat.

Dhanyavaad.

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