Reserve Bank governor, D Subbarao, today said that tensions between fiscal and monetary policies during the stimulus exit pose a threat to the independence of central banks.
"Beyond the short-term, the threat to the independence of central banks emanates from factors apart from public anger...as countries contemplate exit from these expansionary policies, the familiar tensions between monetary and fiscal policies are showing up again," Subbarao said at a conference.
He cautioned that these tensions were unlikely to terminate even when world economies recover from the financial meltdown, raising questions on the autonomy of central banks worldwide.
"Many believe that these tensions are temporary, and will melt away once recovery takes root...that may not well be the case," Subbarao said.
Noting that Government debt in advanced economies is projected to jump from 78 per cent of GDP in 2007 to 118 per cent by 2014, Subbarao said higher fiscal dominance may impede the autonomy of central banks.
"In such a scenario, what are now seen as cyclical fiscal deficits may, in fact, morph into structural fiscal deficits. We may then see the return of fiscal dominance and undermining of the independence of central banks," Subbarao said.
Last month, the Governor had said that the reversal of monetary accommodation cannot be effective unless there is also a roll-back of Government borrowings.
Signalling its exit from the easy money policy, the RBI last month hiked the cash component banks have to park with it by 0.5 per cent to 5.75 per cent absorbing Rs 36,000 crore from the system.
Subbarao said the crisis has dented the credibility of central banks worldwide and said that the case for central bank independence is coming under increasing assault as a result of crisis-led developments.
On capital flows, the Governor said that capital flows can also potentially impair the financial stability of the economy.
Later, talking to reporters, Subbarao said the Reserve Bank has adopted a calibrated approach towards the management of cross-border fund-flows.
