Central bankers were once known for their reticence. They are now judged by their public image. This change in expectations from the men who run monetary policy did not serve Urjit Patel well in his early weeks as governor of the Reserve Bank of India (RBI). His reticence during the entire demonetization episode was misunderstood as a lack of independence. The later patchy communications entrenched this view.
I have been lucky to meet the past six RBI governors at fairly regular intervals. Each brought his own unique style to work. Patel is not one to fall prey to the easy temptations of grandstanding. His sudden resignation thus suggests that the reason he quit was a serious one.
Patel has also been one of the most scholarly governors India has ever had. Not only did he continue to publish his own academic research, but he also tried to deepen the research capabilities at the institution he ran. Private conversations with him can easily slip into arcane issues of monetary economics, the work of great Indian economists, and economic history, and be about mentors such as Deena Khatkhate and T.N. Srinivasan. However, central bankers should not be judged by their intellectual pursuits alone. Patel had three central contributions as RBI governor.
First, he oversaw the smooth transition to the new monetary-policy framework, not only in the technical sense of making the consumer price index the nominal anchor of monetary policy, but also in the way he allowed the role of the governor to change from the final decision maker on interest rates to becoming just one member among six in the monetary policy committee.
Second, he overturned the earlier culture of regulatory forbearance, undoubtedly helped by the introduction of a formal insolvency law that empowered creditors. Patel took on the powerful as he asked banks to take big defaulters to the insolvency courts, made it tougher for banks to misreport bad loans, and stepped in when the boards of private sector banks maintained silence about their chief executive officers.
Third, he stood up to the government right from the early decision by the finance ministry to summon the monetary policy committee members to New Delhi just before they were to meet to decide interest rates, to the more recent pushback on banks under preventive corrective action or the planned raid on the statutory reserves of the central bank.
Some of these achievements overlap the work done by his recent predecessors. There were stumbles as well, especially in communicating what one of the main public institutions in the country was up to, as well as managing the internal frictions within the RBI. It is fair to say that the former overwhelm the latter.
The entire episode of his resignation leaves a bitter aftertaste. The relations between the government and the RBI have been tense for more than a decade now. The smooth collaboration between Yashwant Sinha in New Delhi and Bimal Jalan in Mumbai is now a distant memory. The Indian central bank has been under fire—and insiders have for long claimed that there is a broader agenda to cut it down to size.
One counter view is that there is no such thing as independence from the sovereign in a democratic republic; so central bank independence is a silly demand. This is a straw-man argument. No sensible person believes that a central bank can have statutory independence. The closest any central bank has come to formal independence is the European Central Bank, but it is the creation of a treaty rather than a national government.
The point is not statutory but operational independence is quite a different matter. The RBI does not—and should not—decide its policy goals. They are given to it by law as well as the monetary policy agreement. The governor is also appointed by the government. He needs the operational independence to pursue these goals. The reason this arrangement exists across the world is that a central bank has a different objective function than a finance ministry, even if the final goal is the same. To slip into the language of game theory, governments and citizens are the players in a trust game, while the central bank is designed as a credibility device.
The sort of operating freedom that central banks need to do their job is by nature ambiguous, so formal law needs to be backed by strong norms. That is why the breakdown of trust in recent years is a problem. There is another specific angle in the Indian case. The earlier generation of economic policy officials formed a tight network based on personal trust built over decades of working together. There were always back channels at work even when relations between the finance ministry and the RBI were tense. That stabilising network no longer exists.
The Urjit Patel resignation episode is by itself not going to change India’s economic trajectory. But it could put the system down a slippery slope leading back to the old view that a central bank is just a department of the finance ministry, existing to meet the fiscal needs of the government of the day, and ready to crank the printing press on demand. The question is not of one individual but of a deeper institutional arrangement.
Is it okay to go back to the old days? Perhaps it is, but at the very least consistency demands that we realise how going back to the future will necessarily also mean deeper capital controls, financial repression and directed credit. Think about it.
Niranjan Rajadhyaksha is research director and senior fellow at IDFC Institute. Read Niranjan’s previous Mint columns at www.livemint.com/cafeeconomics
Comments are welcome at email@example.com
Milestone Alert!Livemint tops charts as the fastest growing news website in the world 🌏 Click here to know more.