In an interview, Rajaraman stressed the need for RBI to be more transparent in its functioning while urging both the central bank and the government to show restraint and respect each other’s point of view at the board meeting on Monday. She also highlighted how independent directors on RBI board are becoming more aware of their role and responsibilities. She also stressed the need for central bank to not slip into Latin liturgy where RBI thinks that the public cannot comprehend or understand its actions. Edited excerpts:
You have said that RBI should not fall for the Latin liturgy syndrome. Are you hinting at reforms?
Latin was used in the church to impart a sense of profundity in what was being done which common people couldn’t understand and still went along with it.
I think in a lot of what RBI does, there is this sense—I am not attributing it to the present governor—an institutional sense that there are things that have to be done in public interest which the public cannot quite comprehend. That has to go. I think there has to be a sense that the public can understand if they are made to understand.
Are you saying that the public is more aware now?
The questions that North Block is raising exhibit a fairly nuanced understanding of a number of issues. Let’s say the 12 issues that were raised by the government in the three letters to RBI. I was quite surprised at the depth of understanding in North Block of the various issues and in particular on the reserves issue. I think it was time the question was asked and RBI was made to defend its particular level of reserves.
Mr. Malegam, who is considered a high priest on the reserves issue as he has been on the board for so many years and has chaired a couple of committees on it, has said that under Article 58 of the RBI Act, there is no provision for transfer of reserves to the government. I do not agree with him there.
Yes; of course, in Article 58, there is no explicit provision for transfer of reserves, but then again, there is no provision that reserves must not be transferred. There are a lot of things unsaid in the legislation and for the government to have identified that hole and to say that there is possibility of transfer and tell us why you cannot transfer. And even mentioning the ₹ 3.6 trillion—I don’t know from where they got that number. But anyways, it exhibits some calculation of what is possible.
There is no question that the whole thing is motivated by the present fiscal crisis in the government. (Finance minister) Jaitley is saying that he will hold on to 3.3%. I don’t see how that can happen. This comes from desperation but there is no doubt that there is keener delving in the North Block into the functioning of RBI.
In addition, there have been many regulatory lapses during the last year which have led to a sense among the ministry of finance and educated watchers that the regulatory plumbing needs to be overhauled.
In a sense, you are saying that the government has opened up RBI to a public debate probably for the first time.
During my four years on the RBI board between 2011 and 2015, it was a very cordial period in the functioning of the RBI. I was the most vocal person on the board. I pointed out a number of things to the board that they weren’t aware of.
For instance, the RBI annual report is a submission of the board of RBI to the ministry of finance and not of the RBI management to the ministry of finance as was the general impression.
The annual report used to be placed in the draft form for a 15-minute examination by the board before it was pulled away for finalization. I used to speak up and tell my board members that this is going from us and we should read this. In the four years, I was probably the only one who insisted on a draft and having a video link with RBI in Mumbai with my comments on every page of the draft.
I am sure I was considered a nuisance but I took my responsibilities seriously as a board member of RBI and wanted that the annual report should be accurate portrayal of RBI’s functioning.
The board for a long time was not aware of its powers. In a certain sense, this confrontation has brought to the fore the role of the board, its powers and responsibilities and made the management more aware that they are accountable.
Otherwise, things that they did were considered to be a black box out of which things emerged. But people did not really think that they have the right to look inside the black box.
The central bank feels that the black box is necessary in some cases, especially with corporates on the board of the central bank who may get directly impacted by the central bank’s decisions. For instance, the 12 February circular impacted most industrialists.
There are industrialists on the board…There are people with special interests and so on. It should still be possible for the management of the RBI to say this is what we are doing. If it impacts you negatively, it impacts someone else positively. On balance, taking everything into consideration, we have decided this is what we want to do. The response to special interests on the board cannot be non-engagement. There has to be engagement. The special interests have to feel free to express their opinion and their interest. And RBI can say that we appreciate your point of view, but there were other considerations in play.
RBI has to engage as its actions impinge on everyone in the country. There has to be more transparency and more willingness to talk to people who do not understand the intricacies but are still in need of an explanation.
How did RBI look at independent directors on the board so far?
The relationship was extremely cordial. There was mutual respect but it was all done in a non-intrusive kind of way. There may be here and there an instance of someone raising a valid issue and the management will say we will look into that and refer it to a committee. There was never a confrontation in the sense of an independent director or a board member pointing out a lacunae or deficiency in the functioning of RBI.
In the years leading up to 2013, there was a lot of forbearance in the banking regulator’s approach to long maturity infrastructure loans and they were given ability to roll over loans. On regulatory forbearance, I and other members of the board did raise issues. The NPA (non-performing asset) problem was not nearly as bad as it is today but still these were taken on board.
In May 2013, it was announced that such loans, even if they are restructured once, will be classified as NPAs. But a two-year leeway was given and it was implemented from May 2015.
So, expression of concern by independent directors was taken on board. They were not batted away. RBI management never said that these were immaterial or insignificant. But they were accommodated at a slow pace.
What we have today in the confrontation is independent directors demanding greater immediacy in response. I am raising this issue and I want you to respond to this now.
What is the cause for the immediacy now?
I don’t think it is very profitable to look into the motivation behind why ministry of finance is acting like it is. It is definitely coming from a very tight fiscal situation. And of course, in the case of NBFCs (non-banking financial companies), there is a worry about the liquidity situation. And a concern that RBI is not sufficiently responsive.
I don’t think they are just motivated by the fiscal concern. There is the liquidity concern also which could be termed as in the public interest.
The important thing is that RBI has to look into each issue on its merit.
For instance, on the liquidity issue, the government asking for a calculation of the liquidity squeeze, or asking why does the central bank think that liquidity is adequate; I think the ministry of finance is perfectly justified in it.
And if there are members on the board who have the technical skills to take up the matter and contest RBI’s claims, I think they should go ahead and say that.
I think that would make the board a more meaningful body than it has historically been. Especially, at this stage when we are facing a tight liquidity crisis which could become a systemic crisis. It is a financial stability issue. Financial stability, even with prioritization of price stability, is a primary concern of RBI.
On the reserves issue, it is a fiscal drive. There are three categories of reserves. There is an asset development reserve which is like a depreciation reserve. There is a valuation reserve, which is the largest component, and consists of gains from revaluation of gold and foreign exchange reserves.
Revaluation reserves is just a balance sheet balancing entry and as it stands, it is unrealized. But the minute it is realized, it can be transferred. It is not that it is unrealizable, it just hasn’t been realized so far. Contingency is for unforeseen eventualities. But in principle, contingency reserves can be subjected to an examination to the volatility in various variables.
It is like an insurance provision and like any insurance, it is amenable to actuarial calculations.
All of this should have been readily available in some department of RBI. Even if someone comes from the outside and challenges the RBI on its reserves, RBI should be able to defend itself. RBI should welcome challenges and answer questions on the reserves.
How independent can independent directors be in a board meeting? Will they side with the government or will they take an impartial view?
Independent directors at my time were indeed very independent. There were academicians, bankers and had no political party affiliations. We all functioned independently. But that situation can change if the government appoints an independent director who is known to have a particular objective in mind. An independent director may be known to have an allegiance to some way of thinking.
All of us are appointed by the government. Other than the examination of whether you have paid their taxes, no other check is done. We don’t know if the government of the day has had a conversation with the independent director on the stance they want to take.
I am not aware at all in my time that the independent directors thought that they owed any special allegiance to the government because they appointed them. But the whole environment was completely different. We had received no instructions whatsoever.
There is a political question here as well. How to contain the damage if the governor and the deputy governor (Viral Acharya) resign? What would you advise the government to ensure that the resignations do not happen?
I don’t know what is the government’s strategy in going into this meeting. I think the resignation of these two people will be really catastrophic. What it would do is to convey to the whole world that there is political turbulence in India impacting the central bank which is a defender of financial stability and there will be an outflow of capital.
I think the strategy for the government while going into the meeting should be to say to the RBI senior management that we are not your enemies. We are your friends. We want you to stay in. We want to present to the world that we can resolve our differences. We do want you to explain to us your thinking and we will only ask relevant questions. We will not heckle you. It should not be done in a hostile way where you don’t question the formula but the motivation behind it.
What RBI must not do in this confrontation is to be dismissive of any issue brought before it. They should never say that this is beyond your understanding.
For the government, they have to go with the determination to prevent the resignation of the governor.
Suppose the worst case does happen and there is outflow of capital. We are the fag end of this government’s tenure. What are the public policy options available?
I don’t want to even think about it. It will be so disastrous. There has to be a head of RBI who has to take the decision like how to stem the capital outflow. Unless the government has a name of someone who can immediately take over, I see disaster.
Your stand has been that RBI is the custodian of reserves and there is certain autonomy attached to it.
Absolutely there is. But at the same time, the sovereign is supreme. But the sovereign, in its right as the supreme authority, has the right to ask the custodian what their assessment is of the optimal level of reserves. RBI has to be able to convince the sovereign that this is the level of reserves that I think should be maintained. On top of that, the sovereign will find it very difficult to fire the custodian. The custodian also cannot remove itself from questions.
Due diligence is performed at the time of appointment of RBI governor. If you are firing this person, then that means that you haven’t exercised due diligence at the time of his appointment. You are admitting your mistake.
Do you think government’s argument to get the RBI aligned to its way of looking at public interest might have taken a beating with demonetization?
Yes; absolutely. Demonetization was a difficult time. According to the RBI Act, decision to withdraw notes in circulation has to be taken by the board of RBI and communicated to the government whereas in this case the decision was taken by the government and communicated to the board couple of hours before the decision was actually announced. In fact, that was a serious violation of RBI law and it happened. No one has challenged it. That was the period when RBI willingly went along with the government, willingly suspended its disbelief even if it had any disbelief. Then there were a lot of processes to demonetization which were completely beyond anyone’s comprehension. It was most amazingly, badly handled demonetization even as a process, forget about the decision itself. ATMs had to be reconfigured, that is the utter disaster that it became. It is possible that what we had today is a sort of collateral damage of that. Now RBI might be getting forced to correct its own reputation. So, is it a demonetization hangover?
Let’s call it collateral damage from that. They want to be seen to be amenable to everything that the government suggests. There are many things the government could have done but unfortunately it has found expression not in an issue-specific manner. Instead of condemning the regulator in a broad-brush kind of manner, very specific questions could have been asked about responses to circulars, supervisory college meetings etc, which did not happen.
You have seen RBI from within, but we know very little about it from outside. So, what is it that makes this institution unique in India?
What is very admiration-worthy of the RBI, especially given our cultural context, is that institutionally, even though they have hierarchies like all institutions have, in a meeting, the junior-most research assistant can disagree with the senior-most official present, as long as he or she can justify his stand. This is the most inclusive thing about RBI. In fact, the senior-most people will turn to the junior-most people and say you are fresh from college; tell me what you think is right. They can stand up and tell their senior-most official, ‘I don’t think that is the right way to go’. But equally impressive thing is once a decision is taken, which of course is taken by the senior person, they all fall in line. They don’t go out of the building and say this crazy decision went against my conviction. That is very impressive. There is respect for professional and technical capabilities of all kinds. For example, on adequacy of reserves, it is most likely that a very junior person in the institution has been assigned this job. The second thing is that it has an incredibly good environment for women. I have never been to an institution where women are respected as much as in RBI. I am really a great admirer of this institution. I will really weep if the RBI were to be destroyed as an institution though I have been very critical of its regulatory lapses. It’s such a bulwark of our country. I just hope it comes through this crisis OK, but I hope they come out of it with the recognition that banking regulation and supervision and non-bank regulation and supervision all needs to be tackled.