Does the RBI ‘Walk Alone’? Often, suggests former governor Subbarao

Growth is as much a challenge as inflation. If the government has to walk alone to face the challenge of growth, then we will walk alone,” said P. Chidambaram, then finance minister, in October 2012, in response to the Reserve Bank of India’s (RBI’s) decision to keep interest rates unchanged.

RBI, then headed by Duvvuri Subbarao, a career civil servant who had been appointed by Chidambaram himself, had chosen to keep rates steady because inflation was running high at a time when growth was shaky. The Wholesale Price Index had remained in the range of 7-8% in the months between April and December 2012. Industrial growth, as measured by the Index of Industrial Production (IIP), was volatile, swinging from -2% in June 2012 to 8.4% in October 2012. There were also questions about the government’s commitment to fiscal consolidation, which was weighing on RBI’s decision on interest rates.

All things considered, Subbarao’s judgement was to keep interest rates steady. Chidambaram was clearly miffed and decided to use the moment to publicly rebuke RBI. It was, in many ways, the outing of the worst-kept secret of the Indian economy—that the central bank and the government are in a constant tug of war on interest rates even though RBI is technically independent and has full powers to set interest rates.

Subbarao recounts that incident in his book, Who Moved my Interest Rate?, which released on Friday and uses it to try and answer the question on how autonomous RBI really is.

“The events leading to this public rebuke of RBI started unfolding in the week before the policy,” writes Subbarao. “In the pre-policy meeting with him, I told Chidambaram of my decision to stay pat on the policy rate in view of the inflation situation and the continued concern about the fiscal situation which was undermining the fight against inflation. He was clearly unhappy with my proposed decision, was upfront with it and strongly argued for a rate cut. I did not believe I could yield.”

In the time between the pre-policy meeting and the actual policy, Chidambaram decided to unveil a fiscal consolidation road map. It was announced a day ahead of the policy and Chidambaram made it clear that he expected RBI to take note of it.

“I am making the statement so that everybody in India acknowledges the steps which we are taking. And also acknowledges the government is determined to bring about fiscal consolidation. And I sincerely hope that everybody will read the statement and take note of that,” Chidambaram had said at the press conference.

Subbarao saw this as an “unsubtle message” to RBI.

“I have high regard for Chidambaram’s competence; if there was one person who could deliver on the demanding fiscal deficit target in an admittedly complex and challenging political scenario, it was he. Even so, I was disinclined to change my decision based on his fiscal road map as it was a mere reaffirmation of the targets with no indication of the steps that would be taken to deliver on those targets,” writes Subbarao.

In recounting the incident, Subbarao makes the point that the Indian government has often tried to influence monetary policy decisions in various ways. There are many times when the government wants lower interest rates and makes no bones about it in private even if they publicly say that the decision is RBI’s to take. And when governors have failed to yield to these requests, they have paid the price.

In Subbarao’s case, this price came in the form of public shows of disapproval, and also through the rejection of his recommendations for deputy governors.

Subbarao, in his book, speaks of the government’s decision to reject an extension for both Usha Thorat and Subir Gokarn.

“There is a price to pay, of course, for not falling in line. The government has several ways of showing its displeasure, and the way they chose to do so with me was by going against my recommendations in the reappointment of deputy governors in the bank.”

Do incidents such as these prove RBI is not independent? Subbarao says he does not have a “binary answer”, but his book offers a nuanced response.

As part of his writing, Subbarao quotes his predecessor Y.V. Reddy.

“The Reserve Bank is totally free within the limits set by the government,” was Reddy’s way of responding to the question of RBI’s independence.

“The answer is clever, even technically correct, but still ambiguous. What indeed are the limits set by the government? Are they well defined, and is there a shared understanding on both sides of their respective obligations and code of conduct? What are the remedies if there are transgressions?” asks Subbarao.

The book by the former governor dovetails with a debate over the government’s meddling in the Reserve Bank’s affairs.

The current debate was sparked by current RBI governor Raghuram Rajan’s June decision to step down after he completes his first three-year term in September.

Rajan chose to publicly announce his decision and suggested that while he was open to continuing in office, he had eventually decided otherwise.

Why Rajan took this decision and why the government didn’t back a competent governor when he was attacked by Bharatiya Janata Party politician Subramanian Swamy are the questions being asked.

It’s quite possible that the answer to these questions also lies in the disconnect between RBI and the government’s priorities. The former’s dharma is inflation control, while the latter may choose to focus on growth in the short term for reasons that are not purely economic.