Why India Needs to Rethink the RBI–Finance Ministry Relationship in a ‘Goldilocks’ Economy

As India steps into 2026, the macroeconomic picture looks unusually comfortable. The Reserve Bank of India (RBI) Governor has described the economy as being in a “Goldilocks” zone — growth is robust, inflation is low, and financial stability risks appear contained. Yet, precisely because conditions are benign, this may be the best moment to tackle one of India’s most persistent structural problems: the tangled and conflict-ridden relationship between the “Reserve Bank of India” and the “Ministry of Finance”.

Why capital costs matter after labour reforms

With major labour reforms now in place, the next frontier for sustaining high growth is lowering the cost of capital. That requires deeper financial markets, more efficient credit allocation, and a vibrant bond market. However, these objectives are constrained by the unusual institutional architecture governing India’s financial system — where the RBI is regulator, debt manager, and market participant, while the government remains a dominant borrower and owner of banks.

This “nested” relationship has long created conflicts of interest that blunt market development and weaken regulatory effectiveness.

The uneasy marriage between Mint Street and North Block

The RBI–Finance Ministry relationship is often likened to a traditional marriage: disagreements are settled behind closed doors, separation is unthinkable, and when disputes surface, the government’s view tends to prevail. Occasionally, however, the tensions spill into public view.

One such moment came after the massive fraud at “Punjab National Bank” in 2018, involving Nirav Modi and Mehul Choksi. Then finance minister “Arun Jaitley” publicly blamed the RBI for weak oversight, prompting the central bank to counter that its regulatory powers over public sector banks (PSBs) were severely limited.

Subsequent years have only reinforced that concern. PSBs have written off roughly ₹12 trillion in loans between FY16 and FY25, far exceeding comparable stress in private banks.

Why regulating public sector banks is inherently conflicted

The RBI approves and vets CEOs of private banks to ensure they are “fit and proper”, but it has no such authority over PSB leadership. PSB chiefs ultimately answer to the Finance Ministry, not the RBI, diluting regulatory discipline.

The conflict deepens because RBI officials sit on PSB boards. This means the central bank is simultaneously a board participant and the regulator — blurring accountability and weakening supervision. Repeated waves of non-performing assets suggest this arrangement has failed to deliver effective oversight.

As early as 1998, the Narasimham Committee-II recommended that RBI nominees be removed from PSB boards and that boards be professionalised. Yet, both the RBI and the government have resisted this reform.

The bigger conflict: RBI as debt manager and monetary authority

An even more consequential problem lies in the RBI’s role as the government’s debt manager. As the entity responsible for managing public borrowing, the RBI has an incentive to keep interest rates low so the government can borrow cheaply. As a monetary authority, however, it is meant to prioritise inflation control and financial stability.

This conflict is magnified by India’s high combined fiscal deficits. To support government borrowing, banks are required to hold government securities through the statutory liquidity ratio (SLR). While the SLR has fallen from nearly 40% in the 1980s to 18% today, India remains among the few countries — alongside Bangladesh and Pakistan — still relying heavily on this tool.

How financial repression hurts market development

The continued use of SLR represents a form of financial repression. By forcing banks to allocate a large share of funds to government bonds, it crowds out private credit and stunts the development of a corporate bond market.

The impact is visible in the data. India’s private credit stands at around 50% of GDP — well below economies such as Vietnam, Thailand, and Malaysia, where it exceeds 100%. Shallow bond markets and bank-centric finance raise capital costs for firms and limit long-term investment.

Why debt management reform keeps stalling

Twice — in 2007 and again in 2015 — finance ministers “P Chidambaram” and Arun Jaitley announced plans to shift public debt management away from the RBI to a separate National Treasury Debt Office. Both times, the proposals were quietly shelved.

A debt management unit was eventually created within the Finance Ministry, but the “Comptroller and Auditor General of India” has flagged weaknesses in its functioning. Crucially, the fundamental conflict — the RBI managing government debt — remains unresolved.

Former RBI deputy governor “Viral Acharya” has described this as fiscal dominance, documenting how it crowds out private investment, weakens monetary transmission, and slows financial deepening.

Why 2026 is the right moment for reform

There is rarely a perfect time to undertake difficult institutional reforms — but current conditions come close. Inflation is below the lower bound of the flexible inflation targeting framework, growth remains strong despite global headwinds, and the RBI has already begun easing interest rates.

This reduces the political temptation to rely on fiscal stimulus and opens space for credible fiscal consolidation. The upcoming Budget offers an opportunity to start untangling the RBI–government relationship in a way that strengthens market discipline rather than undermining growth.

A logical starting point: ending the SLR

A bold but logical first step would be phasing out the statutory liquidity ratio. Doing so would force a clearer separation between monetary policy and fiscal financing, deepen bond markets, and put pressure on the government to rein in deficits through more transparent borrowing.

Ultimately, modernising India’s financial system requires acknowledging that well-intentioned institutional compromises of the past now impose real economic costs. In a “Goldilocks” moment of stability, postponing reform would be far riskier than embracing it.