Rarely has the credibility, role and autonomy of the RBI been so openly discussed and debated as now. Rarely has the credibility, role and autonomy of the RBI been so openly discussed and debated as now.

A decade ago, a top official in the Finance Ministry called up a senior RBI official to discuss a proposal that the minister was keen on. When pushed on the proposal, the RBI official told the civil servant, “If you want me to do what the minister wants, it is best that you make the RBI a department of the Finance Ministry.” The official said he was just a messenger and that’s where it ended.

That informal conversation didn’t lead to any major rupturing of ties between the Indian central bank and the government, but five decades ago, it didn’t end too well. Then, following differences with RBI governor Benegal Rama Rau, T T Krishnamachari, finance minister in the Nehru Cabinet, had said that the RBI was like a “division of the Finance Ministry”. That and other events were enough for Rau, the longest-serving RBI chief ever, to put in his papers, days before his second term was to end.

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Such tension between the monetary policy authority and those in charge of fiscal management in New Delhi are inherent. However, events over the last couple of months have led to questions as to whether this ‘inherent tension’ was missing as the government announced its decision to withdraw Rs 500 and Rs 1,000 notes and subsequently, in the handling of the exercise by the government and the central bank. This has led to people such as former prime minister Manmohan Singh (himself a former RBI chief), former finance minister P Chidambaram, and former RBI governors Y V Reddy and Bimal Jalan raising concerns about the “harm” to the RBI’s “credibility” and talking of the “institutional damage” it has “suffered” in the process.

Rarely has the credibility, role and autonomy of the RBI been so openly discussed and debated as now. There have been questions on the central bank’s leadership, especially on its disquieting silence during the handling of the demonetisation exercise, one of the most significant policy moves in the country’s history.

A former minister, who has worked closely with the RBI, says the “reputational integrity” of the central bank has been dealt a blow in the wake of demonetisation. It doesn’t help that Governor Urjit Patel has to depose before at least three parliamentary panels — the Public Accounts Committee (PAC), the Department Related Committee of Finance and the Parliamentary Committee on Subordinate Legislation (before which he has already appeared) — to explain the demonetisation exercise. As reported by The Indian Express, in a note late last month to the finance panel, headed by Congress leader Veerappa Moily, the RBI, while agreeing with the rationale behind the note ban, had said it was the government which “advised” it to do so.

“The admission by the RBI in its note to the parliamentary panel — how, a day after the government ‘advised’ it to ban high-value notes, it convened a meeting of its defunct board (the Central Board) — is a clear indication that the bank leadership has submitted to the wishes of the government and compromised with the central bank’s integrity. The manner in which the RBI handled demonetisation, especially the frequent modification of rules, and the way the Governor remained silent for weeks in this age of transparency show that its autonomy has been impaired,” says the former minister on condition of anonymity.

Arun Shourie, Union minister in the Vajpayee Cabinet, is scathing in his indictment of the RBI. “In its craven note (to the parliamentary panel), the RBI has slavishly reproduced some of the arguments trotted out by the government — like terror threats and black money (as justification for demonetisation). The Governor caved in and has turned out to be an under secretary in the Ministry of Finance,” he says, adding that the Governor’s job is to provide independent counsel to the government. “It is clear that he didn’t do it and didn’t stand up and thus, forfeited his responsibility.”

The RBI did not respond to an email by The Sunday Express seeking comments.

While hard questions are now being raised on Patel’s leadership, when he was appointed in September last year, he was only seen as someone who kept a low profile, a perfect foil to his more flamboyant predecessor, Raghuram Rajan. While Rajan was as comfortable talking to an audience of schoolchildren as he was in the company of high-street bankers, Patel, an accomplished macro-economist with degrees from the London School of Economics and Oxford and a PhD from Yale University, was known to be reclusive.

That wasn’t necessarily an undesired trait, many said then, since central bankers are supposed to be conservative, but the days after demonetisation called for clarity, and the reluctance or failure of the RBI chief to communicate during this crucial phase may have hurt the RBI, they say now. Apart from a joint press conference with Shaktikanta Das, Secretary, Department of Economic Affairs in the Finance Ministry, immediately after Prime Minister Narendra Modi made his demonetisation announcement on November 8, Patel has only held one press conference so far — on December 7 — after the monetary policy review.

Rakesh Mohan, who was deputy governor and secretary (Economic Affairs) in the Finance Ministry, says that once the government took the decision, the RBI should have done all the communication with the public, rather than let the government do the talking. He says that every fortnight or so, the Governor should have communicated. Instead, in the days after demonetisation, Shaktikanta Das was a regular on television, announcing one change of rule after another.

Unlike other major economies, the role of the RBI is far more central in India given its mandate to supervise banks and the payment system in a country where millions still don’t have access to the formal banking system. With the government and the RBI entering into an agreement on inflation-targeting, the central bank is now also a formal inflation-fighting institution. Any potential damage to its reputation can hurt it in the eyes of overseas investors and agencies. Besides, it may impair its ability to exercise not just legal oversight over those entities, but more importantly, its moral influence.

Mohan’s former boss, Y V Reddy, who served as RBI chief between 2003 and 2008, said in a recent interview to CNBC-TV18 that “credibility” and “public trust” are of utmost need for a central bank, not just as an issuer and custodian of currency but also to ensure financial stability in a $2 trillion economy. “For a central bank, reputational risk is the worst risk, credibility is the worst risk. And if this is happening… I would say that it is a national problem now and it is not just a political issue,” Reddy had said in the interview.

Mohan says that after the demonetisation announcement, “the RBI should have sought time from the government to work out the mechanics of best implementing the ban with the least disruption”. The former minister too is of the view that the RBI ought to have taken full control after the decision to pull out the notes. “The entire exercise was political with the announcement being made by the Prime Minister, and that’s why it was important to retrieve ground after that,” he says.

Not everyone is willing to assign all blame on the central bank. K C Chakrabarty, former deputy governor of the RBI, says, “If the government ‘advised’ the note ban, that’s the government’s view. Why blame the RBI alone?” On the silence of the RBI and of Patel, Chakrabarty says, “It’s not that he was speaking earlier and isn’t speaking on demonetisation now — he wasn’t speaking on any issues. That’s his nature. You can’t change that.” Mohan says that while Patel’s self-effacing nature should be respected, “the problem is, there is no rational debate on the role of the institution”.

A debate on the autonomy of the RBI has been underway over the last few years ever since the UPA government decided to implement the recommendations of the Financial Sector Reforms Legislative Commission. The government had then taken away the RBI’s debt management role, a move that many said ended up clipping the powers of the bank and diluting its primacy among all regulators.

Repairing the potential damage to the institution is bound to be a challenge, says former governor Jalan, who perhaps had one of the best equations with the government (both the United Front and NDA) during his tenure between 1997 and 2003. While saying that the RBI’s autonomy should be maintained, he says, “On monetary policy issues, there should be consultation with the government. But the government should agree with the RBI’s final decision, even if it is difficult,” he says.

There is a view that the mandate of the RBI should be in the statute so that it is protected from the political dynamics of changing governments. “The Reserve Bank has a mandate that is wider than that of most central banks across the world. This is an arrangement that has served the economy well,” said a former governor. Unlike the Comptroller and Auditor General of India and the Election Commission, the RBI has no constitutional backing.

The former minister, however, disagrees. “After all, within the existing legal framework, past governors, including the last one, Raghuram Rajan, have resisted governments’ efforts to push through their policies.”

Mohan, the former deputy governor, says it is now important for the government to take special steps to ensure that the “dignity of the central bank is restored”. According to him, that would mean improved communication between the RBI and the government, more leeway to the central bank on senior appointments, and strengthening of the RBI Board. “The RBI had traditionally a board of repute, representing various fields. Getting in top-quality board members will help the Governor obtain different views and the institution will benefit too,” he says.

Currently, of the 10-member RBI Central Board, six directors (Governor Patel, four Deputy Governors, Shaktikanta Das and Anjuly Chib Duggal, Secretary, DFS) are from the RBI and the government. However, the government can nominate 10 directors from various fields, apart from the two government officials (Das and Duggal). Minister of State for Finance Santosh Kumar Gangwar told Parliament last month that “at present, 10 positions of non-official directors on Central Board of Reserve Bank are vacant”.

For now, says the former minister, “What you need (in the RBI) is someone who will assert his authority like we have with the Election Commission and the judiciary.”

Governors vs Governments

Bimal Jalan: In 1998-99, soon after the NDA government led by Atal Bihari Vajpayee took over, a few senior Cabinet ministers started speaking openly on the need to have a strong rupee. That was impeding the RBI’s currency management strategy and leading to more volatility in the markets. Governor Jalan protested to finance minister Yashwant Sinha and later sought a meeting with the prime minister to request government functionaries from pronouncing on the rupee. It had the desired impact after word went out from the prime minister

Y V Reddy: A proposal to utilise India’s growing foreign exchange reserves (during 2004-5 to 2007-8) was mooted first by the Planning Commission and then by the government. That put the government in conflict with the RBI, which was opposed to the proposal. It was sorted out only after Governor Reddy insisted that the government provide a guarantee on lending by a government-backed entity, the India Infrastructure Finance Company Limited, from part of the reserves. In another instance, after Reddy made a mention of Tobin tax (tax on spot currency conversions) on capital flows in a speech, citing it as an empirical case, the government forced the Governor to clarify that there was no intention to tax inflows

D Subbarao: The formation of the Financial Stability and Development Council or FSDC headed by the finance minister was a flash point between the finance ministry and the RBI. The central bank’s rationale was that the primary responsibility of stability was with the RBI and the new arrangement could undermine its influence. The government still went ahead with the proposal when Pranab Mukherjee was finance minister. The other major dispute which played out in the open was on interest rates, when P Chidambaram, as finance minister, was pitching for lower interest rates at a time when inflation was still relatively high. When the RBI didn’t oblige, he went on to say that “if the government has to walk alone to face the challenge of growth, then we will walk alone”. That prompted Subbarao to respond, a week before he completed his term: “I do hope that the finance minister will one day say that I am so frustrated by the Reserve Bank that I want to go for a walk, even if I have to walk alone. But thank God the Reserve Bank exists”

Raghuram Rajan: In 2015, when the government incorporated a provision in the Finance Bill without consulting the RBI — assigning the responsibility of regulating the money markets to SEBI — the RBI protested fiercely. Rajan took his objections to the finance minister and the government, leading to the proposal being rolled back

WHY AUTONOMY OF RBI IS KEY

Targeting INFLATION: With a formal mandate to combat inflation, allowing it to choose tools to achieve inflation target is critical

Currency management: As issuer of currency, important for RBI to be seen as upholding faith, trust

Soundness of banking system: As banking regulator, exercises oversight over banks — big and small

Financial stability: Critical to functioning of financial markets

Regulator of payment systems: Handles transactions valued in billions

Merchant banker to govt: Handles debt management functions, borrowings for Central, state govts

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