RBI-govt rift: What was the fuss about?

Within 48 hours of Urjit Patel's resignation, Mr Das assumed charge at the RBI

No, the heavens haven’t fallen. Foreign investors haven’t fled. The rating agencies haven’t downgraded India. The markets haven’t collapsed — on the contrary, the Sensex has gained nearly 3 per cent since the new Reserve Bank of India (RBI) governor was appointed and the yield on 10-year government bonds has fallen. This, despite the political uncertainty created by the results of state elections.

For more than a month preceding the appointment of Shaktikanta Das as RBI governor, media commentators and experts had created a sense of crisis, if not a looming national disaster, over the differences between the government and the RBI. The resignation of the RBI governor, we were told, was a “nuclear option” that must never be exercised. 

Well, Dr Patel did resign. Within 48 hours of his resigning, Mr Das assumed charge at the RBI. Not only was the sense of crisis quickly dispelled but there is now a certain optimism in the air, one that is reflected in the bounce in the markets. Critics of the government may believe that the appointment of a bureaucrat augurs ill for the RBI but the markets don’t seem to think so.

Now that the media frenzy has died down, it’s worth making a few points that run counter to the prevailing wisdom. First, we may think of the worst of politicians but it is incorrect to suppose that politicians want pliable individuals to head institutions such as the RBI. In a democracy, politicians understand that economic performance is crucial to their winning and staying in power. And they do recognise the importance of strong institutions in delivering economic performance. 

Secondly, it is not true that India’s politicians focus entirely on short-term outcomes at the expense of long-term outcomes. If we look back a longish period starting with the 1970s, economic outcomes have improved with each passing decade, with the exception of the second half of the present decade. Surely, this could not have happened if our politicians had been blind to the long-term implications of their policies. They certainly cannot afford to be so in an economy that is today more integrated with global financial markets.

Thirdly, the particular suggestions from the government that have led to tensions with the RBI cannot be construed as attempts to infringe the autonomy of the central bank. Take, for instance, the issue of the appropriate level of reserves for the RBI. This is a technical matter on which reasonable people can legitimately differ. It is entirely appropriate to refer the matter to an independent committee. This would not have happened had the government not pressed its point vigorously. 

The same can be said of the government’s contention that there are issues of liquidity in particular sectors, such as non-banking financial companies (NBFCs) and small and medium-enterprises (SMEs). Finance Minister Arun Jaitley was right in pointing out at a recent economic conclave that when the government receives representations on such matters from industry, it is justified in initiating a discussion with the RBI. Similarly, the government’s view that the PCA regime is a trifle too stringent and needs to be aligned with global standards cannot be dismissed out of hand. Central bank autonomy does not mean that the central bank’s positions cannot be contested. 

India is not alone in having tensions between the central bank and the government. This is a phenomenon we are seeing in many other countries. Some three decades after central bank independence was enshrined as a lofty goal of economic management, the tenet is now coming under attack. There is growing unease among politicians, former central bankers and academics over the role of central banks.

In the US, President Donald Trump, not known for mincing words, says the US Fed has “gone crazy” in raising interest rates. Former Bank of England Governor Meryvn King has accused his successor Mark Carney of pandering to the British government over Brexit. Robert Skidelsky, the famous biographer of Keynes, says that the experiment of independent central banks must be brought to an end.

Economist Lawrence Summers argues that much has changed since the late 1970s, when central bank independence was instituted. In the advanced world, low inflation is more of a problem today than high inflation. Exchange rate policy, which is linked to monetary policy, impacts on industrial and international interests and hence cannot be delegated to a central bank. 

Crisis prevention requires decisions on who is to be saved and at what cost and, again, requires coordination with the government. One might add that regulation too has implications for growth and stability and is too important to be left to the central bank alone.

The limits to the independence of the RBI should be clear enough. If we leave aside monetary policy, for which a separate regime has been instituted, the RBI needs to act in consultation with the government on a range of matters. In the past, such consultations happened directly between the RBI governor and the government. Whether the time has come for such consultations to be formalised under the aegis of the RBI board is worth debating.

The writer is a professor at IIM Ahmedabad

ttr@iima.ac.in