Time was when capital markets put a premium on “strong men". Fund managers backed these political leaders, hoping they would drive tough economic reforms and establish sustainable governance in emerging economies, leading to stable markets and long-term value creation. Sadly, that premium has turned into a discount as markets have realized that the same powers are being used to weaken independent institutions that provide stability to the market mechanism.
Turkey’s example is relevant with the lira having depreciated over 80% against the dollar in the 12 months to September 2018. This is markets reacting to Turkish president Recep Tayyip Erdogan appointing his son-in-law as finance minister, repeatedly undercutting the independence of the Central Bank of Turkey through various declarations and protesting against high interest rates despite the inflation rate ruling above 15% and finally going past 24% in September.
In India, the unseemly drama unfolding at the nation’s premier investigative agency, the Central Bureau of Investigation (CBI), holds multiple lessons about the perils of meddling with institutions. Successive governments have interfered with the agency’s due processes, appointing sycophants as heads and actively subverting ongoing investigations. But the recent episode has exposed the deep rot within the agency.
CBI is not the only institution that faces government interference. The government’s attempts to circumscribe Reserve Bank of India’s (RBI) independence fits into a larger pattern of institutional emasculation. Things must have got serious because RBI deputy governor Viral Acharya used two successive public speeches to communicate RBI’s discomfort with the government’s repeated attempts to undermine the central bank.
No institution is perfect and the RBI is not an exception. Yet, in the short history of independent India’s financial markets, it has acquitted itself well. It is true that the RBI’s ledger has many red marks and there are many things that the central bank could have done better. But it is also true that it has been instrumental in staving off systemic contagion on numerous occasions and has earned the respect of global central banks for its technical expertise.
The immediate motives for the government’s heightened criticism of RBI and its repeated attempts to influence the central bank’s workings through public pronouncements are not known. But this does fall into a prolonged pattern of certain influential elements, both within and overseas, trying to chip away at the central bank’s independence. However, if one were to speculate, the recent provocations also fit in with pre-election patterns, when the political class needs the central bank to keep interest rates low and adopt an easy monetary policy. RBI’s tolerance levels must have been breached and a sharp reaction triggered after three-four events in quick succession.
The first was the Nirav Modi scam in which the needle of blame was conveniently turned towards the RBI. While all the pillars of governance architecture—involving the board, RBI and the government as main shareholder—failed to either prevent or detect the breaches, RBI alone had to shoulder the blame. RBI governor Urjit Patel had to defend the central bank in a March public speech, where he asserted that RBI had differentiated regulatory powers over state-owned banks—for example, it cannot replace the management and the board, or revoke its licence—when compared with private banks.
The second is the government’s attempts to undo a critical piece of RBI’s regulatory action: the 12 February circular in which it redefined a loan default and revised the framework for bad loan resolution. This hurt many private sector enterprises and the decibel level of protests kept rising, including a note of disapproval from the parliamentary committee on finance. RBI, however, remained steadfast in its resolve.
The third provocation was a report from the inter-ministerial committee to finalize the amendments to the Payments and Settlement Systems Act, 2007, headed by the secretary from the department of economic affairs, Union finance ministry. The report recommended the setting up of an independent payments regulator, outside RBI. This got the central bank’s hackles up, given that payments systems are a sub-set of the economy’s currency dynamics. The central bank has promptly submitted a dissent note.
The fourth irritant would have been the government’s choice of directors on the central bank board, marking a sharp departure from accepted practice.
The final straw must have been the economic affairs secretary’s public comments preceding the central bank’s board meeting recently. In a marked departure from accepted norms, he announced how the central bank will be asked to relax its prompt corrective action framework, thereby allowing for increased credit flow to industry.
Eventually nothing came of it, but the episode was highly unusual and distasteful, because no government nominee has ever attempted to shape public expectations on the eve of an RBI board meeting. This aggression from the economic affairs secretary comes on the back of a sustained effort from government, select academics and capital market participants to dilute RBI’s powers and independence. All in the name of achieving market efficiency. Ironically, available evidence shows that markets trust and value independent regulators more than government-controlled patsies.
Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal.