RBI Lost in transmission

After nationalisation, RBI lost control of interest rate transmission mechanism

Dialogue of the Deaf
The Government and the RBI
Author: TCA Srinivasa Raghavan
Imprint: Tranquebar
Pages: 304
Price: Rs 599
 
The first step Mrs. Gandhi took for fulfilling her father’s dreams was to nationalise fourteen private banks with deposits of not less than Rs. 50 crore on Friday, July 19, 1969. Between them they accounted for over 90 per cent of banking business in the country. As she would do when she decided to divide Pakistan up in March 1971 or imposed the Emergency in 1975, Mrs. Gandhi acted decisively. Volume Three of the RBI’s official history says that on July 17 she asked L. K. Jha, the RBI Governor to come over to Delhi. Jha thought he was being asked to discuss social control and he took with him a comprehensive note on the subject. When he offered it to Mrs. Gandhi she told him ‘that he could keep the note on her table and go to the next room and help in drafting the legislation on nationalising the banks.’ D. N. Ghosh, a deputy secretary, and R. K. Seshadri who was an executive director in the RBI, were hard at work there. It wasn’t the next room though; it was the RBI building on Parliament Street where the drafting was done.

 
She also asked the Economic Affairs Secretary, I. G. Patel to prepare a speech. Patel reportedly told her to exempt foreign banks and to nationalise only the big banks. When he asked her why, he was told, ‘It is a political decision’. The prize? Complete control by her of the Congress party, which has lasted to date via her descendants. Pupul Jayakar, a close confidante of Mrs. Gandhi later wrote in her memoirs that according to Mrs. Gandhi, she had been pushed into it by her adversaries. ‘They drove me to the wall and left me with no other option’, in her words.
 
The law ministry, too, was involved, obviously. S. K. Maitra was a joint secretary there and he noted that ‘Shri (P. N.) Haksar told me that the Prime Minister has directed that an ordinance for the nationalisation of certain banks be drafted by me immediately.

L K Jha

 
‘He also instructed me to keep the matter completely secret and told me that I should not disclose my movements to anyone’.
 
Possibly the most important consequence of this was that the RBI more or less formally lost its power to set interest rates. True, it had never been fully independent in this regard—the bank rate was kept at 3 per cent from 1935 to 1952 even though the RBI had wanted to increase it from time to time. But after bank nationalisation and the resulting dominance of the Finance Ministry over the banking system, the RBI also lost control of what these days is called the transmission mechanism. Indeed, such was the disempowerment of the RBI that when its board met a few days after the nationalisation on July 23, no records were kept of the discussion. The whole meeting was described in a single line: ‘There was a brief discussion on the implications of the bank nationalisation ordinance.’ When the board met again on July 30, L. K. Jha told the members that ‘…the RBI will continue to be responsible for monetary policy and ensuring compliance…by the nationalised banks.’ But this would soon be proved wrong.
 
A connected issue, which has been re-echoing now for a few years, was of setting up a body that would control these fourteen banks. It was, in a sense, the idea of a holding company but not in the corporate sense. Within a few days of it being suggested in Parliament, it was ruled out because no one really knew what it would entail. Nor did anyone know what to do next. The political purpose had been served and the commercial aspect would be left as is for some time. The banks would now take their orders from the government, not the RBI whose wards they were supposed to be by law.
 
All that the RBI would do for the next two decades was to exhort them and inspect them but without much power to penalise them. Resources transfer in the country would now happen via the banking system and progressive taxation, which also acquired a new life with the marginal tax rate reaching 97 per cent in 1973 and staying at over 90 per cent through the 1970s.
 
In 1970, Mrs. Gandhi presented the Budget and this is what she said in conclusion. It is worth quoting … because it laid the framework for economic policy for the next two decades, and perhaps even beyond.

 
‘The provision of adequate employment opportunities is not just a welfare measure. It is a necessary part of the strategy of development in a poor country which can ill-afford to keep any resources unutilised or under-utilised….The weakest sections of the society are also the greatest source of potential strength. We cannot provide for all the urgent needs of society with our limited resources. But a balance has to be struck between outlays which may be immediately productive and those which are essential to create and sustain a social and political framework which is conducive to growth in the long run.
 
‘I would like to say that in presenting my first Budget to this Honourable House, I have become acutely aware of the challenges as well as the constraints of the contemporary epoch of development of our national economy. I [have] endeavoured to set out the broad framework within which this Budget is cast. That framework, I believe, is consistent with the political, economic and social realities of our country. Convinced as I am of its essential soundness, there is no alternative but to tread a difficult but determined course. If the opportunities for growth which are so much in evidence are to be seized fully, no effort must be spared for raising resources for the purpose…. The fiscal system has also to serve the ends of greater equality of incomes, consumption and wealth, irrespective of any immediate need for resources. At the same time, the needs of those sectors of the economy which require private initiative and investment must also be kept in mind in the interest of growth of the economy as a whole. I can only hope that the proposals I have just presented steer clear of the opposite dangers of venturing too little or attempting too much.’
 
Thus began a process that in the 1980s degenerated into competitive populism. But in 1970, for a country looking for a fresh whiff of leadership, new ideas and desperate for reassurance that someone was at last in charge, these ideas came as a clarion call comparable only to the ‘tryst with destiny’ speech of Nehru twenty-three years earlier. In terms of contemporary relevance, it was like the election campaign speeches of Narendra Modi during October 2013-May 2014.
 Excerpted with permission