New Delhi, Nov 17 (Bloomberg):

The government has proposed changing rules that will enable closer supervision of the Reserve Bank of India (RBI), people with knowledge of the matter said, a move that may undermine investor confidence in the world’s fastest-growing major economy.

Prime minister Narendra Modi’s administration has recommended that the board of the RBI draft regulations to enable setting up panels to oversee functions, including financial stability, monetary-policy transmission and foreign exchange management, the people said, asking not to be identified as the discussions are private.

The move is meant to empower the regulator’s board, which includes government nominees, and give it a supervisory role, the people said. The central bank’s board is scheduled to meet on Monday. The tension mirrors central bank fights playing out in countries as varied as the US and Turkey, and is a symptom of what happens when an era of easy credit ends.

The latest proposal may heighten tensions between the finance ministry and the RBI, which have been at logger heads over a host of issues that will be discussed at Monday’s meeting, including transfer of surplus funds, easing of bad loan norms, and ensuring liquidity to the shadow banking sector. While the government says the central bank isn’t providing support to boost growth, the RBI says fund transfers could undermine its independence and hurt the markets.

“This does look scary and comes at a slightly anxious environment for investors,” said Hugo Erken, senior economist at Rabobank International .

“This does not bode well in the short term for confidence and the Indian rupee.”

Finance ministry spokesman DS Malik didn’t reply to two calls made to his mobile phone, while the RBI spokesman was not immediately available for a comment.

The recommendations being considered include setting up several committees comprising two to three board members each. The body has the powers to frame rules under section 58 of the Reserve Bank of India Act, 1934, and no legislative change is required, the people said.

RBI’s board regularly advises and guides the regulator, leaving decision making to the governor and his colleagues.

However lately, Swaminathan Gurumurthy, a chartered accountant who was nominated by the Modi administration to the board, and government nominees Subhash Chandra Garg and Rajiv Kumar have been vocal about perceived shortcomings in banking supervision, flow of credit to industry and easier financial conditions to overcome a crisis in its shadow-banking sector.

That prompted central bank deputy governor Viral Acharya to warn in a speech last month that a move to undermine the RBI’s independence will attract the wrath of the markets.

The government last month upped the ante by writing to the central bank to discuss issues where there had been disagreements, citing a rule that has never been used in the central bank’s 83 year-old history. Under Section 7 of the RBI Act, the government has the power to issue directions that are binding on the central bank.

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