As India enters 2026, the macroeconomic mood is unusually calm. Inflation has eased from post-pandemic highs. Growth has remained resilient despite weak global demand. The Reserve Bank of India has even described the moment as “Goldilocks”—neither too hot nor too cold. Yet beneath this comfort lies a question India has deferred for decades: can a modern financial system function well when the regulator and the government remain so closely intertwined?
The RBI was never designed to be an ivory-tower institution. In the era of planned development, it worked alongside the government to direct credit, finance public borrowing, and stabilise a low-income economy with shallow markets. That compact suited its time. India today, however, seeks deeper bond markets, efficient banks, low-cost capital, and long-term global investors who trust institutional boundaries. Those ambitions sit uneasily with a system in which the central bank is simultaneously regulator, government banker, debt manager, and, at times, silent partner.
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Public sector banks: where regulation meets ownership
The costs of this proximity are most visible in public sector banks. These institutions are regulated by the RBI but owned by the Union government, which appoints their leadership and shapes incentives. When failures surface, scrutiny often turns to the regulator. In practice, senior management understands where ultimate authority lies.
Over the past decade, taxpayers have repeatedly recapitalised these banks, while bad loans running into trillions of rupees have been written off. The pattern is familiar. Board oversight is diluted. Market discipline is weak, reinforced by the assumption of state backing. Regulation is most constrained precisely where ownership is strongest.
Coordination in crises—and the price of permanence
Supporters of the current arrangement argue that proximity enables swift coordination in times of stress. During crises, the government and the RBI can act together to stabilise banks, calm markets, or support growth without public friction. They also warn that a fully independent regulator could become technocratic and inattentive to social priorities such as employment or credit access. In a democracy, economic power cannot be entirely divorced from political responsibility.
The argument deserves consideration, but it has limits. Independence is not a guarantee of wisdom. Global experience shows that central banks can misjudge risks, as they did before the 2008 financial crisis. Tightening cycles in advanced economies have also produced painful spillovers for developing countries. Independence without transparency can create institutions that speak more to markets than to citizens.
India’s problem, however, is not excessive distance from politics. It is the reverse.
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Debt management reform: promised, postponed
Nowhere is this clearer than in public debt management. The RBI manages government borrowing while also setting interest rates and supervising banks. The conflict is obvious. A borrower prefers low rates. A central bank is tasked with controlling inflation and preserving financial stability. When deficits are large and persistent, this tension becomes structural.
Banks are encouraged—by regulation and convention—to hold government securities. Private credit competes with sovereign paper. Over time, lending to businesses suffers and bond markets struggle to deepen beyond government debt.
Successive governments have announced plans to move public debt management out of the RBI. A debt management unit was created within the finance ministry, but without autonomy or market credibility. Reform stalled on the claim that shifting borrowing away from the RBI could create execution risks.
That caution has hardened into habit. Expertise can be transferred. Governance can be built. What cannot be justified indefinitely is the assumption that delay carries no cost. It does—through blurred incentives, weak market signals, and recurring pressure on bank balance sheets.
Fiscal dominance and the limits of partial reform
India’s institutional overlap reflects more than administrative convenience. It points to fiscal dominance. When government borrowing remains large and persistent, monetary policy operates within an implicit boundary. Even without direct pressure, markets read interest-rate decisions through the lens of borrowing needs. Credibility then depends not only on inflation outcomes, but on whether the central bank is seen as free to act when trade-offs arise.
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The Monetary Policy Committee was meant to address this concern. It narrowed discretion in rate-setting and improved transparency. But it did not resolve the deeper conflict. Liquidity operations, bond-market management, and government borrowing remain closely linked. A committee may vote independently, but markets respond to the full institutional arrangement, not to statutory design in isolation.
This overlap also enables quasi-fiscal action without explicit budgetary scrutiny. Regulatory forbearance, liquidity support aligned with borrowing cycles, and the preferential treatment of government securities quietly substitute for open fiscal choices. Often defended as temporary or stabilising, these measures become structural when repeated.
The cost shows up in market development. Price discovery weakens. Corporate bond markets remain shallow. Banks stay anchored to sovereign paper rather than risk-priced lending. India’s financial system remains bank-heavy well beyond what its income level would suggest.
Clarity of roles, not absolutism
The debate should not be framed as independence versus control. It is about clarity. A regulator that supervises banks should not sit on their boards. A central bank that sets interest rates should not also be responsible for ensuring the government borrows cheaply. A professional debt manager should focus on maturity profiles, risk, and market development—not monetary signalling.
This is also a moment when reform is easier. Inflation is manageable. Growth is steady. There is no crisis forcing hurried choices. That creates space to act from strength. Gradual change—phasing out distortive regulations and strengthening arm’s-length institutions—would deepen trust rather than weaken coordination.
Strong relationships survive on clear boundaries. India’s financial governance has functioned for decades without them. If the country is serious about becoming a developed economy, drawing those lines can no longer be deferred.