T C A Srinivasa-Raghavan: The gorilla and the RBI

A basic reform may quietly be rolled back by the UPA government

The Reserve Bank of India (RBI) will announce its 'slack season' credit policy today. A great deal of attention is being focused on what it will do with respect to interest rates. Will they go up, down, or remain where they are?

If I may copy Amitabh Bachhan, this interest in the interest rate is interesting. It suggests that the markets have now come to believe that monetary policy has become an integral part of the policy instruments fully available to the Bank.

Implicit in this belief is the assumption that the Bank is now a free agent, able to discharge its responsibility and exercise its judgment as it thinks fit.

But is this correct? Has reform really percolated so deep that the government has begun to respect the Reserve Bank? As Chou Enlai said about the significance of the French revolution, it might be too early to tell.

While the free agent assumption is doubtless true for most of the areas in which the Bank functions, is it true of monetary policy? Is fiscal policy (politics) driving monetary policy once again""just as it used to before the 1990s?

To put it even more simply, can the Bank ignore the 900-pound gorilla"" which is how a colleague on this newspaper's editorial board described the government's borrowing requirement? No one can ignore a gorilla, never mind its weight. The RBI is not an exception.

That this fiscal gorilla constrains the Bank's freedom in using the interest rate freely is obvious. But that doesn't make it any the less important because of the institutional implications that are entailed.

In this instance, for example, it leads to several uncomfortable questions like who is responsible for this gradual but unnoticed reversion to the old days, when the Bank had to do as bidden? Who is quietly eroding the fine balance that the finance ministry and the Bank had evolved between 1992 and 2004?

The truth is not very comforting, at least where our perceptions with respect to the commitment of yesterday's reformers to the most basic reform of all are concerned. By a strange twist of fate, the culprits may be the very men who had enabled that balance to evolve.

This is truly saddening because as finance ministers through much of the 1990s, Manmohan Singh and P Chidambaram had made very significant contributions to re-inducting monetary policy as an important instrument of macroeconomic policy. Indeed, for Dr Singh this was a logical movement.

Through the 1970s and half of the 1980s, he had seen the other side and knew where the economy could end up if monetary instruments were treated as being of no consequence, paying court to fiscal policy whenever required.

Mr Chidambaram didn't have the hands-on knowledge of Dr Singh but he was a willing learner. But now both seem to be bent on undoing what they and their successors, Yashwant Singh and Jaswant Singh, had achieved between 1998 and 2004.

In their anxiety to appease the Left and the NAC, they could be squandering a very positive achievement of economic reform, namely, the fine balance between the government and a central bank.

It also raises the old issue of the relationship between the Bank and the government. Without overly stressing the obvious fact that the government has to be the boss because that is how these things work, it also needs to be said that the relationship cannot be that of what tort law calls a master-servant relationship.

Indeed, even if the lawyer in the finance ministry sees it like that, the economist in the PMO must surely see it differently, and prevail upon the lawyer to alter his views?

Or is it that he, too, is reverting to old days when he could treat the RBI like a subordinate office, asking it to alter the rate of interest applicable to a commodity at will?

The point, therefore, is this. Throughout the 1990s, all the finance ministers understood the importance of allowing the RBI greater freedom and acted accordingly.

The high point of this generosity, if it should be called that, was the MoU between the finance ministry and the Bank which limited the amount of government borrowing that could be monetised. With this the Bank gained much of the ground it had lost over the previous two decades.

Indeed, it was this rebalancing and understanding by the finance ministry and the PMO that allowed the last two governors of the 1990s to be so hugely successful. When, before the 1990s, was an RBI governor feted as much as a finance minister?

Both those governors owed a significant part of the success to a simple fact. This was that the government was willing to alter the relationship in favour of the Bank by not insisting on the pre-eminence of fiscal policy.

It is also interesting to note that neither of these two highly successful governors was from the civil service. Both were gifted economists who had served the Bank and the government, respectively.

This is not to say that civil servants have not been highly successful as RBI governors. Some have. But the economist-governor has always been less accommodative of the government. Of course, there have not been too many.

This perhaps reflects how civil servants and non-civil servants view the government. It could even be a fit subject for structured research. Whence, finally, the question: Is the government now forcing the Bank to cede back ground to it? It is beginning to look very much like that.

If the government insists on going on a spending spree that (because disinvestment and privatisation are out of favour) is largely financed by borrowings that may eventually have to be monetised because there are no other takers for its paper, there is precious little the RBI can do. It has to fall in line after sounding the usual warnings. It is, after all, the sovereign's banker.

We have seen this happen before and we have seen the consequences. In the end the issue is not only about interest rates and whether they go up or down by a few basis points every now and then.

That they will, as they have always done. It is also about how the agencies of the state relate to each other. The Marxists have a clear idea of this relationship, even if it is based on flawed economics.

But does the UPA?