India is possibly regressing back in reverse direction. When Nobel Laureate Amartya Sen had commented few months back about India’s move into ‘Quantum leap backward’, NITI Aayog vice-chairman Rajiv Kumar was highly unhappy. The issue got so much heated that, it went into a public debate on TV requiring Professor Sen to prove his point. Today, no debate is required to prove the point about India’s quantum leap in the backward direction with the resignation of Reserve Bank of India’s Governor Dr. Urjit Patel. Raghuram Rajan termed this extraordinary situation as “ultimate statement for the regulator” and a matter of concern for everyone, “because the institution is really important”.
Urjit Patel’s step was highly speculated since the recent (mis)historic November 19 meet of government representatives on RBI Board with RBI governor using a special clause Section 7 in the RBI Act 1934, which was almost never used in the RBI history. The essence of the point was the way government compelled RBI Governor to come to table to discuss certain contentious issues forced upon RBI, which obviously the Governor never wanted to find himself in. But that happened and unfortunately happened- Section 7 was used unceremoniously, which should have been applied under ‘rarest occasion’. In fact, RBI had already made it clear its stand on those issues- leaving no ambiguity about RBI’s autonomy as well as its independence in thinking as the monetary authority of the country. When Dr. Patel could not voice from the front, keeping the reputation of the institution in mind, he strategically guarded RBI’s autonomy as well as his own standing by fielding his hawkish deputy Viral Acharya. Acharya audaciously cautioned that playing with the central bank’s autonomy would be ‘catastrophic’ for the economy and would invite ‘wrath of the markets’.
The world listened with utmost caution. But the government went ahead with its plan- on the so called ‘governance reform’ in RBI. Government was hell bent on getting a sizable pie of the more than INR 9 trillion of the RBI’s reserves- which the central bank has carefully kept with itself for meeting financial exigencies & economic crises, stabilizing the foreign exchange rate and the forex market and supporting the economy’s liquidity in times of need. The government argues firstly, to utilize this reserve to fund capital requirement of the public sector banks so as to make them able to lend to the small business sector, specifically to the MSME sector, which were hard hit during Demonetization post-2016. Secondly, the government wanted the central bank to relax controls on the smaller banks so that they can deal with the ongoing crisis in the banking sector. Thirdly, many argued that government also wanted to meet its cash shortages to fund its election year populist programmes. When RBI denied parting with its surplus liquidity, it became the bone of contention between RBI and the Finance Ministry- leading to the unfortunate use of Section 7.
This is being viewed as a colossal case of undermining the Central Bank’s autonomy and reputation as wisdom owl and guardian of the financial system of the country. In the last 70 years since independence, RBI has been carefully crafted into a world class institution of conscience keeper of the country’s financial system- despite numerous cases of tussle between the RBI governors and the Finance Ministry over differences of viewpoints. Many governors including Dr. Manmohan Singh have agreed about the supremacy of the Ministry over the central bank as latter represents the government. Many finance ministry officials have also worked subsequently as RBI governor, appointed by the government, but subsequently they have realized the central banks’ autonomy and charted the path of professionalism. Some agreed to disagree with the government- carefully, wittily like Dr. YV Reddy and took the institution’s autonomy and repute to utmost heights. Some threatened to exit if unduly pressurized by the government over unacceptable terms, like Dr. Singh- who subsequently became more compassionate and understood well the difficulty of a central bank Governor and protected Urjit Patel facing Parliamentary scrutiny over Demonetization.
Nevertheless, some reached the point of difficult disagreements and at least three Governors have resigned before- Sir Osborne Smith before independence, B. Rama Rau in 1957 and S Jagannathan in 1975 last. Now Urjit Patel joins them after a long time, serving for shortest term since the Reforms Era of 1992.
Many governors have penned down their tricky journey in RBI in their memoirs. When confronted with the question about independence of RBI as the monetary policy authority, Dr.YV Reddy very wittily comments, ‘The RBI has full autonomy. I have the permission of my finance minister to tell you that.’ He further opines, ‘RBI is independent within the limits set by the government’ and accepts there is nothing sort of ‘blanket independence’ for the Governor. (Financial Express, June 29, 2017) Dr. Reddy details the tricky issues of dealing with the government in his memoir- Advice & Dissent. Dr. Reddy had characteristic ‘market skepticism’ which faced incongruity with Finance Minister Chidambaram’s absolute ‘market optimism’. Let’s not forget, Dr Reddy’s market skepticism and vehement protection of autonomous monetary policy formulation in RBI during 2003 to 2008 protected India from the onslaught of global financial crisis and witnessed high growth, coupled with low inflation and stronger rupee. Dr. Reddy left RBI with a robust banking system in the end, but without a further extension.
A central bank governor’s job becomes very complicated due to the tight-rope-walk balancing of the ‘growth-inflation conflict’ he faces. When the eternal wisdom of the government tends towards enlarging fiscal deficits, especially for populist purposes, the central bank has to put an astute break on it through his tight monetary policy tools primarily aimed at putting inflation under check. A low inflation creates a conducive environment for low interest rate and enhanced credit flow in the economy thus supporting robust growth in the end. But a tight monetary policy requires higher interest rates as well- in the short run, which the government may think as a growth sacrificing step of the central bank. But the professional monetary policy experts well understand that short run tight monetary policy for controlling inflation creates long run growth prospects in the economy. But the government may well be short-sighted!
The crisis years’ Governor Dr D. Subbarao (2008-2013) faced similar conflicts in his dealing with the government, which he documents well in his memoir- Who Moved My Interest Rate: Leading the Reserve Bank through Five Turbulent Years. He carefully steers the economy in the turbulent times of global financial crisis, took pains to control high inflation and corrected sharp depreciation of rupee. And all these were possible due to his sharp and independent professional management approach. On independence of RBI, none other than Raghuram Rajan, in his famous book I Do as I Do quotes Subbarao who expects the Finance Minister to take a walk one day after getting “…often frustrated by the Reserve Bank”, and finally acknowledge, “But thank God, the Reserve Bank exists.”
But for Raghuram Rajan, simply existence of RBI is not enough- it must have the ability to say ‘No’ when required! On autonomy of the Central Bank he further observes in I Do as I Do, as governments continue to misunderstand RBI’s role,“the RBI risks becoming dangerously weakened”. So he expects there should be “More clarity about the RBI’s role”, with “clearer assertion of its independence”, thatwould be good for the economy and ‘in the nation’s interest’.
The current deadlock hovers over these issues of misplaced understanding on the limits of the Central Bank’s role and functions in areas of regulations- which is left without clearly defined. And hence, any reforms in the constitution of RBI Board and its management must be dealt with substantial debate and deliberations. Until now RBI Board had advisory role, which had government’s representatives who were non-professionals on monetary management. RBI Governor was thus not mandatorily required to obey its advisory mandate. The current government is thinking to modify the ‘advisory role’ of RBI Board into direct ‘operational role’ in monetary management- obviously to more effectively dent the monetary policy space and include its fiscal policy objectives. But this can have perilous repercussions for the nation, as in absence of effective balancing wisdom and restraint, unidirectional collective thoughts can lead to collective folly. That’s why any reforms over the autonomy of the central bank must not be made in hurry. Raghuram Rajan has cautioned this time and again over his dissent over demonetization. Hence, he still prefers new RBI Board to be constituted on the principles of professional management and believes rendering higher operational authority to the RBI Board, “would impinge on the professional management’s capacity to regulate and supervise” (ET, 11 Dec. 2018).
Former RBI Governor Dr. C. Rangarajan also advocates similar principles on the debate over formation of Monetary Policy Committee (MPC) in 2015. He had opined the government can do away with the veto power of Governor if it wished to do so, but he had cautioned the MPC Committee must have majority of members from the RBI. The intention was, RBI as a great institution of monetary management authority, must have its say in the professional management of the economy in matters under its mandate. At present, whether RBI board will have professional monetary experts or not, time will say.
On the current impasse Rangarajan advocates adequate freedom for the RBI for diligent working of the central bank, but he also prescribes RBI and the government to be ‘accommodative and listen to each other’. He thinks the issue of disagreements between RBI and government arise because of ‘the lines are a bit blurred’ in the areas of banking and regulations- not in monetary policy framing, wherein RBI has necessary independence. (Business Line, Dec 11, 2018).
I had the opportunity to listen to at least three former RBI Governors, though all of them had left the Central Bank by the time- C. Rangarajan, Dr. Manmohan Singh and Y V Reddy. Rangarajan was Chairman of Twelfth Finance Commission, where I was an Economic Consultant to Member Secretary Dr. G.C. Srivastava in 2004. Next, I was member of the conference team in the 92nd Annual Conference of Indian Economic Association at Bhubaneswar in 2009 wherein Prime Minister Dr. Manmohan Singh was invited to inaugurate the Conference. I had opportunity to listen to Dr. YV Reddy in the same Conference. I came across their ‘enlightened wisdom’ in their deliberations over issues pertaining to the economy. My observation on them- all three have dealt with different trajectory in the Central Bank and led the economy under difficult situations. Thanks to their ‘enlightened wisdom’! And they never compromised standing for their wisdom! But now the question is, will this ‘enlightened wisdom’ be available so that public trust can be maintained over this Great Institution? Institutions are important- they are symbols of our collective wisdom and decades of perseverance and determination. They should not be undermined for short term gains. Urjit Patel will be remembered for carrying forward the good works and legacy of Raghuram Rajan, especially taking bold steps on cleaning up the NPA mess, despite his erroneous compulsions over Demonetization. But most importantly he will be remembered for ‘Saying No’ in the end and standing upto his ‘enlightened wisdom’! Veteran journalist and RBI Consultant, TCA Srinivas Raghavan in his popular book ‘Dialogue of the Deaf: The Government and the RBI’, reminds Montagu Norman’s view about RBI’s role as a Hindu wife ‘who advises but does what she is told’. Let’s hope her ‘enlightened wisdom’ be paid heed to as well!
The Author: Shri Manoj Kumar Sahoo is a Faculty of Economics, School of Liberal Studies, Pandit Deendayal Petroleum University, E-mail: firstname.lastname@example.org