Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Opinion | Moving out of the shadow of failed demonetization

The recent support for Urjit Patel is an overdue correction after the months of unfair criticism that he had sacrificed the independence of the Indian central bank

The Reserve Bank of India (RBI) has reiterated in its new annual report what it said in the previous one released in September 2017—most of the bank notes that were pulled out of circulation in November 2016 have been returned to it. 

The latest figure is an update of the one released last year, when the central bank had said it would come up with a final number once the onerous task of counting the currency that had been returned was completed. The sheer scale of the counting exercise is not to be scoffed at. There were 1,716.5 crore notes of 500 and 685.8 crore notes of 1,000 in circulation when what has popularly come to be known as demonetization was announced.

A mere 10,720 crore of bank notes were not returned to the banking system. That final number now sits innocuously as an entry in the RBI balance sheet under miscellaneous liabilities. 

The hope that demonetization would be an immense exogenous shock that would make Indians use less cash as well as the belief that the government would get a fiscal bonanza as the central bank cancelled a big chunk of its currency liabilities have been belied. Nor has the Indian economy collapsed in a sorry heap. Yet, it is clear that the loss of economic output as well as individual agony were not worth the pain. 

The Indian central bank can now move out of the shadow of the failed demonetization experiment launched by the Narendra Modi government. Urjit Patel will complete two years as RBI governor in a few days. The early months of his tenure were dominated by the demonetization episode—from actually managing the note swap to dealing with its monetary consequences, as reserve money growth collapsed, the ratio of bank deposits to cash shot up, and the money multiplier rose as a result. The excess liquidity in the banking system had to be sucked out as money market interest rates drifted below the channel of policy interest rates.

Patel had to face a lot of personal criticism as he implemented a decision taken in New Delhi, and his reputation was unfairly tarred by allegations that he was a puppet of the Modi government. It was said—again unfairly—that he had compromised the independence of the RBI. The tide now seems to have finally turned. There is now growing respect for his tough line on several issues that have dominated the financial headlines over the past few months, including his refusal to bend on issue of the resolution of toxic bank loans. 

The change in perception glosses over the fact that Patel has stuck to his guns on several issues right from the start of his governorship. It is thus incorrect to portray his recent actions as a drastic break from the past.

There are three important areas where Patel has made his mark through his tenure as RBI governor. 

First is the way he has nurtured the new monetary policy regime that was then taking baby steps. For example, the decision by all six members of the monetary policy committee to not attend a meeting called by the finance ministry just before the June 2017 interest rate decision was a strong indication of independence. The committee also stood its ground last year amid noisy calls for drastic interest rate cuts.

Second, his tough line on bad loans must have been maintained under immense pressure from special interest groups. The 12 February notification on what banks should do under the new insolvency regime is one indication of his attitude towards the curse of regulatory forbearance. He has also been firm with banks on issues such as disclosure.

Third, Patel has tried to build internal capabilities at the RBI to make it ready for a changing world. Consider the focus on technical research or setting up of a data sciences lab. It is interesting that the annual report released on 29 August also spends some time talking about the future research agenda of the central bank.

What has rankled many—in banks, financial markets and media—is the lack of adequate communication by the RBI. Such reticence could be a liability in case there is a macroeconomic shock, such as a run on the rupee. The confusion in the bond markets earlier this year whether an inflation targeting central bank will also help banks minimise losses in their bond portfolios is another example. Modern central banks that work through the expectations channel need to communicate effectively. 

Another group of critics has argued that the RBI continues to be too conservative on technological innovations such as blockchain and fintech. These are some of the issues that will continue to crop up in public debate -- but they will be part of an open discourse on central bank policy.

The recent support for Patel is an overdue correction after the months of unfair criticism that he had sacrificed the independence of the Indian central bank. 

Was Urjit Patel targeted unfairly for the Narendra Modi government’s decision to pull currency notes out of circulation in November 2016? Tell us at views@livemint.com

Close