RBI, finance ministry and autonomy

A finance ministry statement on Saturday said that “the government fully respects the independence and autonomy of the Reserve Bank of India”.

It’s very reassuring to hear this.

There have been talks on the Indian central bank’s autonomy being compromised in various circles against the backdrop of the so-called demonetization move—how the decision to replace 86% of the currency in circulation was taken in Asia’s third-largest economy and the way it has been implemented. Apart from many others, two former Reserve Bank of India (RBI) governors—Y.V. Reddy (governor from 06-09-2003 to 05-09-2008) and Bimal Jalan (22-11-1997 to 06-09-2003)—have recently joined the debate. Reddy has gone to the extent of saying that he would have resigned had he not been able to convince the government against this exercise.

However, the finance ministry chose not to react to them. It did so after four RBI employee unions wrote to central bank governor Urjit Patel objecting to the ministry’s move to send a joint secretary to coordinate cash operations at the RBI. The unions have found this “unfortunate” and something which “impinged on RBI’s autonomy”.

Probably it doesn’t really matter to the government how the experts and the so-called intelligentsia react to demonetization but employees’ unions do matter as they represent the masses. Besides, they are also part of the RBI and hence they must know the truth (that is, RBI is independent).

I heard P.N. Vijay, an expert in investment banking and wealth management services who also assists the ruling Bharatiya Janata Party on economic and financial matters, speaking from his heart on a television channel. He would not like to give much importance to the governors of Reddy’s ilk. They are the “Lalu Prasad Yadavs” of central banks—bureaucrats sent from Delhi to the RBI without much understanding. Or, something on this line. To be fair to him, he did not say that Yadav would have been a better RBI governor than Reddy the way Haryana health minister Anil Vij said Prime Minister Narendra Modi is a better brand than Mahatma Gandhi for the Khadi and Village Industries Commission’s calendar and diary. (Later he retracted the statement.)

Also read | RBI doesn’t decide anything, all decisions are taken by Modi: Amartya Sen

An old debate

The debate on RBI’s autonomy is as old as the central bank itself. What exactly has happened this time? Why is there so much noise? The government advised RBI to take the call on demonetization and the RBI board obliged the government without losing time. Is this something unprecedented? Does this violate the norms laid down by the RBI Act?

Two sections of the Act deal with this.

Section 26(2) of the Reserve Bank of India Act, 1934 says that on recommendation of the RBI’s central board, the government may, by notification in the Gazette of India, declare that with effect from a date specified in the notification, any series of bank notes of any denomination shall cease to be legal tender. So, there is nothing illegal about the RBI board recommending withdrawal of Rs1,000 and Rs500 notes from the system.

And, Section 7 of the Act says “the central government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest”. So, the government’s advice to the RBI on demonetization is in sync with the Act even though I am not sure whether it was done under Section 7 of the Act or not. I presume that the governor was consulted on this.

In public interest?

The moot question is: was demonetization “necessary in the public interest”? Many feel that it is not and the intense debate stems from there. If it is not, RBI should have put up at least a semblance of a fight, they feel. Since RBI has not done that, I think at this point both the government and the RBI are on the same page—both believe that demonetization is for the greater good of the public and the long-term gains will more than compensate for the short-term pains. Had the RBI board deliberated on this a little longer, probably people would have been convinced on this. Any way, only time will tell whether this prognosis is correct or not.

Five Indian states are going for polls, beginning 11 February. Will these polls be a referendum on demonetization? May or may not be. The narrative of the demonetization story is a fight between good and evil, poor and rich and oppressed and the oppressor. Told nicely, the story can touch the heart of the masses and despite sufferings, they can continue to give a thumbs-up to demonetization.

Had RBI not been convinced about the efficacy of the move, could it have stopped it? Probably not, as under Section 7 of the Act, the government can “direct” the central bank. However, it could have fought against it—in private as well as in public—as the appearance of autonomy is as important as actual autonomy itself.

Also read | Demonetisation and monetary policy

The history of central banking in India is replete with many such fights. The title of the book of former governor D. Subbarao (05-09-2008 to 04-09-13) Who Moved My Interest Rate? itself is a testimony to this. His predecessor Reddy too was involved in similar fights—which were more severe than an India-China war, a colleague of Reddy says in jest—but the details are not in the public domain. Reddy’s run-ins with the finance ministry were more on specific issues while Subbarao fought on broader policy issues.

Creative tension

Reddy always downplayed the fights, terming them “creative tension” but those who had seen the period from close quarters vouch that there was nothing creative about it and the tension was at times unbearable. Reddy fought hard against the government’s plan to create sovereign wealth funds and use of foreign exchange reserves for infrastructure development. The finance ministry went to the extent of reaching out to the board of the central bank, seeking help to convince Reddy but he did not budge an inch from his stance.

He also made the finance ministry accept that RBI should have the last word on foreign investment in a holding company of a large private bank (ICICI Bank Ltd). The bank had planned to float an intermediate holding company for its insurance and mutual fund businesses and even sold a substantial stake in the proposed holding company to a few foreign investors. The government approved the plan and even the foreign investment promotion board that deals with overseas investments in local firms cleared the proposed investment by foreign funds in this venture. RBI refused to clear it and, with extreme reluctance, the finance ministry accepted the central bank’s proposal to form a working group to look into the proposal. The working group took its own time to frustrate the bank and prospective foreign investors in the venture before saying it was not “desirable”!

When former finance minister P. Chidambaram called the then deputy governor Rakesh Mohan for an “interview”, which the ministry was conducting through a committee to identify Reddy’s successor, Reddy was not kept in the loop. That was the finance ministry’s way of insulting Reddy. The ministry did the same thing to Subbarao—by not accepting his recommendation for giving another term to his deputies, first Usha Thorat and then Subir Gokarn. In Subbarao’s own words, this is the price he paid for asserting autonomy.

His first brush with the ministry came in June 2010 when an ordinance was promulgated empowering the finance ministry to resolve all disputes between the regulators. This was when the Financial Stability and Development Council was being constituted. Subbarao immediately wrote to then finance minister Pranab Mukherjee, saying “the very existence of a joint committee (the council) will sow seeds of doubt in public mind about the independence of regulators”.

“The ordinance has seeming implications for regulatory autonomy and sows seeds of doubts where none exist. My earnest request to you is to allow the ordinance to lapse. If that option is not acceptable, the portion of the ordinance relating to the RBI Act may be deleted.”

Mukherjee did not pay heed.

Subbarao was also not comfortable with the idea of divesting RBI of its debt management function and had strong reservations on the report of the Financial Sector Legislative Reforms Commission, which has proposed taking away many of RBI’s functions.

A governor, annoyed and upset

The RBI employees unions’ objection to a joint secretary coordinating cash operations at the RBI reminds me of Subbarao’s reaction when in October 2008, in the aftermath of the collapse of US investment bank Lehman Brothers Holdings Inc. and the acute liquidity crisis, the then finance minister Chidambaram appointed the then finance secretary Arun Ramanathan as the chairman of a panel on liquidity management, without consulting the RBI. Subbarao was “annoyed and upset” and called up the finance minister, saying the regulator would not participate in the committee.

The governor’s frequent fights with both the finance ministers Mukherjee and Chidambaram on interest rates too are well known.

Subbarao’s successor Raghuram Rajan (04-09-2013 to 04-09-2016), who received a lot of flak from some quarters for talking beyond central banking in public fora (on intolerance, “make for India” instead of “make in India”, among others), also had his quota of fights with the ministry on issues such as funding Punjab government’s food purchases (there was a massive gap between the worth of food stock and the money borrowed from banks) and the trillions of rupees of debt restructuring of power distribution companies, among others.

Also read | Protect autonomy of central banks for stable growth: Raghuram Rajan

Rajan also put his foot down when the finance ministry in February 2014 wanted RBI to pay an interim dividend ahead of the end of its accounting year in an effort to bridge India’s fiscal deficit and stick to the estimated deficit target. The RBI follows a July-June accounting year and transfers the surplus in August. In 2015-16, it transferred Rs65,876 crore surplus as dividend to the government, Rs20 crore less than the previous year.

Rajan was also against the idea of using RBI’s surplus fund to take stakes in banks or create a state-owned bad bank. The idea was first floated by Chief Economic Advisor Arvind Subramanian in the Economic Survey for 2016-17. “RBI’s capital could be used in two ways. It could be injected directly into PSBs which will give them financial room to accept losses on bad assets and continue lending. Alternatively, funds could be used to create a ‘bad bank’ that would be used for resolving bad loans, thereby forcing PSBs to focus on their normal commercial activities,” the Survey said.

Successive RBI governors have also resisted government pressure on making the central bank’s staff regulations statutory in character. Currently, the staff regulations are governed by the RBI’s administrative decisions but once they become statutory, the approval of the government would be mandatory.

Is the cause worth fighting for?

In short, there have been innumerable instances of the Indian central bank fighting with the government on many fronts – it has lost in many cases and won quite a few. The core of the debate is whether the cause is worth fighting for. So far, most cases where RBI has chosen to fight–and has lost or won-have been related to certain segments of economy and they did not have the kind of impact on a nation of 1.3 billion people, which demonetization is envisaged to have. Many in the ruling government feel this is the biggest economic reform India has witnessed since independence–bigger than the goods and services tax or GST and even the 1991 chapter when, under the pressure of the worst-ever balance of payment crisis, Indian economy embraced liberalization. It would change India forever by stamping out parallel economy and ushering in a cashless payments system.

Is RBI a believer in the demonetization exercise or a reluctant supporter of the move? If it is the latter, then it should have given a fight. Irrespective of a win or loss, that would have made people perceive that the central bank is independent, as public perception about autonomy is as important as autonomy itself.

Also read | RBI’s Urjit Patel says demonetisation to have transformative effect on economy

Former RBI governor I.G. Patel (01-12-1977 to 15-09-1982) once said: “Don’t nitpick. Pick your battles. Once you have picked your battles, fight those battles valiantly.” This was an opportunity for a valiant fight only if the RBI was not convinced about demonetization’s success. But the regulator gives the impression that it is convinced of the success. So, why believe that it has surrendered its autonomy? Wait till we see the end or question its wisdom.

Meanwhile, since this government wants to change India, it can do many other things. They may not be as seminal as demonetization but nonetheless can change the contour of the financial sector and regulations. Two such things could be, dropping Section 7 from the RBI Act and bringing down the government’s stakes below 51% in public sector banks through amendments of Acts.

I am sticking to only the financial sector and not talking about making political parties disclose donations of even less than Rs20,000 and paying income tax on all donations.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo