Writing in this space almost a month ago (“Ill winds blow on Mint Road", 8 October), I had warned that, in my judgement, the Narendra Modi-led government was getting ready to turn the screws on the Reserve Bank of India (RBI) and its governor, Urjit Patel. Regrettably, that is exactly how matters have played out since then and we are currently on the cusp of a crisis that is unprecedented in our post-liberalisation economic history.

The history and main points of contention will be familiar to readers of this newspaper and need not be rehearsed here. The crux is that the government appears to wish to weaken or erode the functional (if not legal) autonomy of the RBI, by imposing its will across a range of areas—including, judging by press reports and what I have been told by credible sources, an attempt to extract some of its “excess reserves" and put those into government coffers. Some reports suggest that the Union ministry of finance is eyeing 1-2 trillion of the RBI’s reserves, which is a not inconsiderable sum of money and which would be unprecedented in the modern history of the institution.

The reportage is murky, but some accounts suggest that the government has already invoked, or is preparing to invoke, Section 7, which permits it to direct the RBI to undertake specific actions in the national interest. This article has never been invoked, not even during the 1991 liberalization nor in the aftermath of the global financial crisis, and would be a clear red line for any central bank governor. This could well be the straw that breaks the camel’s back for Patel.

It is not necessary for me in this space to repeat the canonical arguments for central bank independence. Indeed, deputy governor Viral Acharya superbly did just this in his recent Shroff memorial lecture, which brought the dust-up between the RBI and the government into public view. In a nutshell, governments are tempted to prod the central bank into excessively loose monetary policy, as this can help temporarily pep up the economy—useful in the run-up to an election—but the cost is higher and more variable inflation in the long run, with no real economic gain. That is why most advanced economies and some emerging economies have firewalled the central bank from political interference, either de jure or de facto.

The bitter irony in the Indian case is that it is the Modi government that enshrined the monetary policy framework agreement (based on inflation targeting) into the RBI Act shortly after it came to power in 2014, at the stroke of a pen giving India a state of the art monetary policy framework as against the archaic framework that had prevailed until that point.

This is one of the Modi government’s most important economic reforms and there is now serious danger that they themselves will unravel it for short-term political gain. The long-term damage to the Indian economy will be considerable if such short-run political considerations are allowed to prevail.

A word must be said about the man at the centre of the storm. When he became governor in late 2016, Patel had the unenviable task of presiding over the aftermath of the government’s demonetization decision, which was handed to him as a fait accompli. He could have taken the easy way out and resigned, which would have plunged the process into chaos and made the pain of demonetization much worse than it ended up being.

However, the true patriot that he is, Patel rolled up his sleeves and got the job done. He himself has described this period as almost war-time currency management. It is no exaggeration to say that Patel is the unsung hero of the demonetization misadventure.

The flamboyant and extrovert Raghuram Rajan was always going to be a tough act to follow, but Patel has more than acquitted himself with honour and distinction. Indeed, I daresay that judged by what a central banker is supposed to do — which is being a central banker, rather than a public intellectual who holds forth on everything under the sun—Patel has been more successful than Rajan.

He is, without doubt, one of the world’s premier central bankers at present.

One can only hope that putative repercussions in global financial markets, which are sure to be severe were Patel to quit or be sacked, will stay the government’s hand, and induce them to walk away from this foolish and entirely avoidable fracas with the central bank.

Quite apart from dire consequences emanating from global markets, it cannot possibly be a good development for the Indian political economy if the central bank is robbed of its hard won functional autonomy. You can bet that the monetary policy framework will soon be rubbished, and Indian monetary policy will become erratic and unpredictable, yet again, something we thought we had confined to the past.

If that happens, without the discipline provided by an inflation targeting monetary policy, which punishes fiscal profligacy through its feedback into inflation, fiscal rectitude, too, will be thrown to the winds.

Writing last month, I recounted an anecdote of someone close to the process telling me ruefully that, with inflation targeting, India probably got a better monetary policy framework than we deserved. The same may be said of the current governor. In Urjit Patel, India got one of the world’s top central bankers. Is he better than India deserves? I fear so, but I hope I am proved wrong.

Vivek Dehejia is resident senior fellow at the IDFC Institute, Mumbai. Read Vivek’s Mint columns at livemint.com/vivekdehejia.

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