Whatever the differences over the demonetisation fallout, there is near consensus over one collateral damage: the reputation of the country’s central bank, the Reserve Bank of India (RBI), has taken a severe beating after 86% of the country’s currency (by value) was withdrawn and not replaced on time. But, worse, there is a growing perception that the central bank buckled under government pressure and rubber-stamped demonetisation. Fingers are pointing at governor Urjit Patel for readily agreeing; this may be jumping to conclusions but governor Patel’s non-communicative mien has not helped matters.
Three former RBI governors have publicly lamented the erosion of the central bank’s relative autonomy. Former governor Y V Reddy expressed concern about the knocks the RBI is taking: “For the RBI, for a central bank, reputational risk is the worst risk…And if this is happening in the international opinion, I would say that it is a national problem now and it is not just a political issue.” Even Reddy’s predecessor, Bimal Jalan, chimed in with his concerns over threats to the RBI’s autonomy. The opening line of former deputy governor Usha Thorat’s recent op-ed was anguish-laden: “It is indeed a sad day to see one of the most respected public institutions in India becoming an object of ridicule and scorn.”
India is only playing catch-up
On closer scrutiny, though, this shouldn’t come as a surprise. India is only following a global trend. The world over, in countries with right-wing governments headed by perceived “strongmen,” the executive has locked horns with serving central bank governors, and in some cases even abrogated the relative autonomy of the central bank. India is only playing catch-up: the refusal to extend former governor Raghuram Rajan’s term, and the growing public perception of Patel’s inability to dissent, further reinforces the notion of India tacking on to a global trend.
Two recent examples testify to the global pattern’s prevalence. President-elect Donald Trump denounced US Federal Reserve chief Janet Yellen on his campaign trail, claiming she was playing politics with interest rates (translation: she was keeping interest rates deliberately low to help Hillary Clinton) and should be replaced. Whether he will follow through on that promise will be known only after Jan. 18.
In England, soon after securing the referendum supporting Brexit, Conservative Party grandees—notably Michael Gove and former foreign secretary William Hague—tore into Bank of England (BoE) governor Mark Carney. They were taking their cue from prime minister Theresa May who, at an earlier party conference, had slammed the BoE for the low interest rates and quantitative easing since it short-changed savers. Carney has since dropped dark hints of resigning.
The relationship between elected politicians and central bankers has always been fraught. The 2008 trans-Atlantic financial crisis has deepened the chasm with central banks being increasingly asked to take on quasi-fiscal responsibilities. This has resulted in increasing institutional friction.
In Japan, soon after prime minister Shinzo Abe assumed office in December 2012, he leaned on the Bank of Japan (BoJ) to print more money and to bump up its inflation target from 1% to 2%; both measures would require the BoJ to pursue an expansionary monetary policy. This, the government hoped, would provide the necessary growth stimulus to the economy and finally help Japan escape the pernicious deflationary trap that’s plagued the economy for over 10 years. BoJ governor Masaaki Shirakawa was initially reluctant and when the pressure continued to pile on, he resigned in February 2013, two months before he was due to retire.
The Hungarian president and head of the right-wing party Fidesz, Viktor Orban (who recently built barbed wire fences to keep out immigrants), used his majority powers in parliament to browbeat the central bank into submission. He even went to the extent of replacing the sitting governor with long-time Fidesz politician Gyorgy Matolcsy. Interestingly, Matolcsy currently faces myriad allegations of cronyism and misuse of public funds, including those of the central bank to window-dress the government’s fiscal health.
Closer home, Sri Lanka has been witnessing heightened tensions between central bank governor Indrajit Coomaraswamy and finance minister Ravi Karunanayake.
More than just monetary policy
Bank of Israel governor Stanley Fischer resigned ahead of his retirement date, sparking off rumours of differences with prime minister Benjamin Netanyahu. Fischer subsequently joined the Federal Reserve as vice-chairman. A year ago, he had delivered a speech on central bank independence, in which he made an interesting point, one that resonates with the Indian situation. He said: “…there is a distinction between the terms monetary policy independence and central bank independence. In the literature that developed before the global financial crisis, central bank independence referred to independence from political influences in the setting of monetary policy. But many central banks have roles outside monetary policy—in particular, bank regulation and supervision. These roles are in certain cases granted their own level of independence…”
This point has also been made by former governor Y V Reddy: “There are two types of confusion… my own suspicion is that the institutional identity of the RBI has been damaged… the RBI is the monetary authority, yes. But it is also a full-service central bank. It is in charge of many other things. The recent emphasis appeared as though monetary policy is the main function. The governor is accountable to monetary policy. Then he is not accountable to regulation, he is not accountable to currency coins? There is a confusion about relative importance. That relative importance is being decided more outside than within.”
Successive governments have found ways of corroding each of these different independent roles. For instance, under the previous Congress-led government, former finance minister Pranab Mukherjee (currently the country’s president) set up in 2013 a new financial sector monitoring body, called Financial Stability and Development Council, to be chaired by the finance minister. This was a clear intrusion; the central bank’s mandate includes financial stability. The RBI governor was put on par with other regulators, which betrays a flawed understanding of a central bank’s role and remit.
The Australian example is instructive. The governor of the Reserve Bank of Australia chairs the single integrated prudential regulator, the Australian Prudential Regulation Authority, as well as the Council of Financial Regulators.
Rule by fiat
The process of emasculating the RBI seems to have accelerated now. The surgical changes to RBI’s governance structure are telling: The government’s unwillingness to fill up vacant posts of independent directors is believed to have accelerated the passage of the demonetisation proposal and helped obtain the central bank’s acquiescence overnight. Ordinarily, the central bank would have debated and dissented, after assessing the logistical nightmare of not only distributing fresh cash to the wide network of bank branches across the country but also recalibrating and replenishing over 200,000 ATMs across the country.
Subsequent RBI submissions to parliament’s committee on finance disclosed that the central bank had acted on government advice.
Truth be told, the RBI Act does not empower the central bank with absolute autonomy, but the RBI does have relative autonomy allowing it to pursue certain monetary and regulatory functions with some degree of independence, free from political pressure. Saying “no” in the interest of avoiding short-term volatility and ensuring the economy’s long-term health is part of the job. Tinkering with this fine balance will have massive repercussions, including undermining investor confidence in various asset markets.