At a regulator’s round table at the Mint Annual Banking Conclave held in Mumbai on 23 January, former Reserve Bank of India (RBI) governor D. Subbarao and former Securities and Exchange Board of India (Sebi) chairman C.B. Bhave talk about the impact of demonetisation, the move towards a cashless economy and the autonomy of RBI in a session moderated by Mint’s consulting editor Tamal Bandyopadhyay. Edited excerpts:
After demonetisation, everybody is talking about growth slowing down. The latest one was the International Monetary Fund (IMF) which said 100 basis point growth will be compromised this year, another 150 basis points next year. India will lose the tag of the fastest-growing economy in the world. In fact, Moody’s said India will continue to remain the fastest-growing economy. Reserve Bank of India (RBI) estimates say that demonetisation impact will be 50 basis points. Can you please tell me how short will be the short-term pain and how long will it take the long-term gain, and what kind of gain do you see?
Subbarao: On the growth numbers itself, I must admit I have not crunched the numbers but I have seen fair estimates, from Dr Manmohan Singh in Parliament saying loss of GDP (gross domestic product) will be 2 percentage points, to RBI saying that it will be 5% but the consensus seems to be above 1 percentage point of GDP.
What is quite clear though, on which there is lot of agreement, is even though we might lose some GDP in one year, recovery will be quite V shaped as we are already seeing that V-shaped recovery, there will be no hysteresis in the sense that once economy is remonetised we will get that trend, loss if any will be one-third loss. Of course, that will be a huge loss. Apart from the loss to GDP, hundreds of million less privileged in the country had endured pain and hardship, and also economic loss. Cost of demonetisation has been direct in the short term, the benefits are uncertain and unquantifiable.
The question is: Will the net cost-benefit calculus be positive. The hope is that it will be positive provided two things happen. The way I look at two methods I use for assessing the success of demonetisation.
The first is to what extent this process destroyed or detected (black money). Second, to what extent is regeneration of black money prevented by demonetisation as everyone has said tax black money, act on time, it does nothing to prevent allegations, it puts a fear like Chinese say they killed a chicken to scare the monkey. So if there is fear in people creating black money that they are going to get penalized, benefits will be quite substantial.
So you are saying that demonetisation should not be the end of it, there should be a series of it?
Subbarao: Absolutely. You know already in reports about people generating (black) money, all the people who come down the system and are detected to have black money. There should be a trail on them.
There should be other mechanisms. GST (goods and services tax) itself might be a big instrument in spotting black money. There should be other audit trails, investigating agency, tax agency. They must use technology.
Most of all, the government must create a fear in people that if they indulge in black money creation. If some people are caught in this operation, it would be great.
How do you see the economy in the next few quarters? In a democracy, we actually need to create fear to implement things—is this the right way to do something?
Bhave: Firstly, I am not an economist. From what I read of estimates that have come out, nobody has a clue. People are still gauging what the impact will be. As third-quarter results of listed companies come out, we will get some indication. There is about one month and eight days of a quarter, which is normal. Sectors likely to be affected will be cash dependent.
Initially, unlisted portion of the economy, informal sectors will be affected more. I neither believe in extreme forecast of 3%, also some people who are saying it’s marginal impact, I think we are going to land somewhere in between.
If you say by 31 March that quarter’s results will reveal the impact, isn’t that too early?
Bhave: (With) March results, which will come out in April, you will know two things. One, the full impact of demonetisation disturbance on companies and the way the economy is recovering because we need to know both these things (to know) what kind of debate it is going to have.
Lot of people are hoping that the recovery will be V-shaped and you will see the recovery coming up as fast as the downturn came in. I don’t know.
Do you have anything to say to what Dr Subbarao said about a series of measures as a follow-up and you need to create fear among people, black money hoarders. Is this the way forward? Do you agree with that?
Bhave: I agree with Dr Subbarao completely that we need to address the flow problem as well. My take on the issue of corruption is that this is probably the most important issue which we tend to ignore. Secondly that in our conversation we discuss it as something outside of the room, not realizing all of us in the room are responsible directly or indirectly for generation of unaccounted money. This has infested our body politics, our social body to such an extent (where) we are in such a state (that) you have a patient with (his) body entirely infected... let’s say, these are the two conditions.
You should not operate on so small a part that as soon as you finish the operation, rest of the body gets infected again; you should not operate on such a large body part, that patient himself will be dead. As if these two conditions were not enough, the knife I am giving you has also poison on it, the machine through which you have to implement is also an issue and, therefore, we are only going to find a long-term answer to it.
I agree with Dr Subbarao that we need to initiate the step, but don’t expect quick results from it.
If you remember Prime Minister’s 8 November address to the nation, demonetisation was about fighting terror financing, fighting counterfeit notes, terrorism. There was no reference to a cashless economy. There was speculation how much money we will get. Then we see the lottery is used to promote the drive to cashless.
Subbarao: If the objective is only to move the economy to cashless, evidently I believe that the motivation of demonetisation was to assault black money. I was also surprised like Tamal that the government in last two-and-a-half months has talked about different objectives at different times and were somewhat muffled in their communication.
I would have been quite happy if they said the intent of demonetisation is to attack black money and there are other incidental benefits of demonetisation such as the transition to a cashless economy to an extent which are consistent with our other objectives.
In your book you spoke about how Denmark and Sweden are becoming cashless economies. As a former regulator, what is the right way to go towards a cashless economy?
Subbarao: Well it is not that I have done extensive calculation on a cashless economy. I must take some pride that I talked about cashless economy before it became such a popular phrase or slogan in our country. I was talking about a cashless economy, of course the benefits of which come out of it including, creating an audit trail. I was talking more in the context of negative interest rate. You go back one year, January/February last year, the big thing around global economy was how negative interest rate is going to work . It will work if you go towards a cashless economy. It was in that context I was motivated to write about economy. I think it is still possible to go towards a cashless economy and pursue the objective of financial inclusion.
From economics to logistics, you spoke about the economics part of it. I would like you to tell us about the logistics part. Being chairman of NSDL (National Securities Depository Ltd), you are somehow the architect of dematerialized shares in India. That was a humongous task at that point of time, physical shares’ transition to demat, scale was much smaller but there may be some similarities. Are there lessons to be learnt from your demat exercise in terms of sequence?
Bhave: It’s an interesting question. As you rightly said that we can’t really compare the two. When we went in for the demat process, we had about 20 million customers. Today, even if you take the adult population as 500-550 million people, there is that difference.
The other important difference is that, in the entire implementation of the demat process ... it was between the regulator and the actors in the demat process like stock exchanges and NSDL, etc. who arrived at most of the decisions.
The impact it makes is that when you don’t have the sovereign, you can’t compel people to do something. You need to do things in the provision of the law.
The Demat law said the investor had a choice in either physical or demat form. We had to stay clear of this. Sebi doesn’t get as much credit for this work but under (D.R.) Mehta’s chairmanship Sebi adopted an absolutely collegial approach to this. We never got the feeling that we were not heard. Third important point is that at such times, the incentive for an actual player is to push for more and more. But in practical terms, considering the size of the country reach it is wiser to go step by step. NSDL played that role, said “no" many times to higher dematerialization because we advised, we will learn from the mistakes.
The last point we made sure small investors were not affected by it. Any shareholder can sell shares up to 500 in physical form.
The Regulator always kept its window open. What you do is 80:20 rule, you are pushing 20% but covering 80% of the market.
If I paraphrase you, the sovereign should not have much role in the entire exercise. We need to leave it to executives, you need to go through a consulting process, you need to sequence it properly and in certain segments give them enough time.
Bhave: Only the first part. I didn’t say that the sovereign should not be a part of it. But I said if the sovereign is part of it, you run across the temptation to compel…where he is not part of the thing that table will be conscious in progressing.
Everybody talks about RBI autonomy, what about Sebi’s autonomy? In 2010 you tested that. There was a fight between the insurance regulator and Sebi, and you lost it. Was that the reason you didn’t get a second term. In my interview, you said “chairmen come and chairmen go". How independent is this institution and what is your take on that?
Bhave: Ultimately any regulatory institution is a creature of law. So it needs to work within parameters of this law. Every single regulatory law in the country has a provision which says the government can issue directive to this regulator to do something.
I am just saying autonomy in a sense is circumscribed by this fact that there is an overlapping provision. In practical terms in my mind autonomy comes from how the leadership of the regulator is removable.
The Constitution makers wanted the Election Commission, the Comptroller and Auditor General of India to be independent offices, the Supreme Court judges, they made provision that these people can be removed by two-thirds majority of Parliament before their tenure ends.
Are you saying it’s not the institution but the leader that matters? At the end of the day, the buck stops at the leader. The same institution can have less or more autonomy. What’s the wrestling power of the leader?
Bhave: The leader matters certainly, you build institutions with the people. You need people who have that assurance and who know they are not subject to arbitrary removal.
They have financial autonomy. In practical terms, autonomy is also determined by what kind of personality people are dealing with issues. People who are sensitive to institutional importance would deal with the same issue in a different way.
Subbarao: I can’t just give a binary answer. I think the perception is much more than the reality.
And that perception arises from the fact that there is a section of the law under which the government can issue any instruction to RBI that it considers in public interest, but after consultation with the governor.
In the last 80 years of RBI history, Section 7 has been quiet inconsequential. That section has never been invoked. The government has never given any instruction invoking Section 7. The belief that RBI is not autonomous because some section is in law, is completely misread. Sometimes there is pressure on RBI to do things that it is not comfortable in doing. I believe RBI is and should be autonomous in close domains of RBI mandates.
Monetary policy, regulation of financial institutions, payment systems on those issues categorically mandate RBI is autonomous and should not bend to the pressure.
Over the last eight years from Sir Benegal Rama Rau to Dr Raghuram Rajan, RBI has maintained the tradition of enforcing autonomy.
You have agreed that it’s this perception that RBI ends up compromising
Subbarao: There is misinformed perception that RBI doesn’t enjoy autonomy and that perception gets strengthened because of repetition.
There is responsibility both on part of the government and RBI to manage and improve this perception. Doing what it believes is in the best public interest no matter what the government believes should be done.
That is number one. First of all, I think body language used should be very mesh. Second, public criticism of Reserve Bank is powerful of course. RBI is a policy institution, it makes policy that affects the lives of millions of people. But there is one exception.
The government should not criticize the RBI governor because that is detrimental to macroeconomic management. If the markets believe that there are differences between the government and RBI, that is not constructive but destructive. The government, if it has any concerns about RBI policy management, that should be internally managed.
You said that in the history of RBI, 80 years now and Sebi, 25-plus years, section 7 was never used. I will ask now a counter question. Why do I need to use section 7? If I advise and you listen to me, in a short notice it is actually a threat.
Subbarao: I think it is exaggerated. On what basis you say RBI autonomy has been touched upon in question of demonetisation. RBI board has taken half an hour, I don’t know exactly. There is no experience. This was a decision that was taken on judgement.
There were people on RBI board. I want to ask a counter question. How long does the Union cabinet take to approve the Union budget? 15 minutes. How long does a state cabinet take to approve state budget? 10 minutes. I can tell you because I was finance secretary of state and finance secretary to state governor.
I believe that the RBI board must respect that they have taken a considered decision.
The governor himself has said that they were in consultation with the government for the past several months. It’s like the army preparing for battle and the decision to attack takes place in a very short period of time.
That is exactly what has happened, I am not an insider anymore. I believe they have been preparing for long time.