Subbarao: Note ban may be akin to Iraq WMD fiasco if results not tangible

The government had anticipated 15-20 percent of black money will be destroyed via its demonetisation move, which actually has not happened, believes the former Reserve Bank governor D Subbarao.“Cost of demonetisation have been huge and benefits are indefinite and unquantifiable,” he said. If atleast one percent is not added to tax to GDP ratio, then the situation will be equivalent to Iraq’s ‘weapons of mass destruction’. Speaking to CNBC-TV18’s Latha Venkatesh, Subbarao said that while the step was a bold one, it was not executed well. It should have been done with more time as the RBI and the government do not work on ‘take it or leave it’ basis. Speaking on the current issue of the Reserve Bank’s autonomy and credibility, Subbarao said that there is insufficient sensitivity in the government towards RBI. The government should cautiously comment in spaces where the central bank has statutory autonomy. However, he further added that the issue of RBI’s credibility been eroded due to demonetisation is exaggerated.Below is the verbatim transcript of D Subbarao's interview to Latha Venkatesh, on CNBC-TV18.Q: The big elephant - demonetisation. We have seen a lot of the pain. Do you think this is pain well taken, do you think it will give us any gain or is that gain uncertain?A: I wish I could give a binary answer to that. As everyone has said the cost of demonetisation have been huge, have been here and now, have been direct. The benefits are uncertain, unquantifiable and in indefinite future. However, it is not clear what the net cost benefit calculus will be but I will use two metrics to measure the success of this. The first metric is to what extent has the stock of black money been destroyed. Second, to what extent is the further regeneration of black money been prevented?On the first metric, on the stock of black money, the initial expectation although the government did not say it in so many words - was that about 15-20 percent of the de-legalised money will be destroyed and that's about Rs 2-3 trillion - that will be a deadly blow to all these people who hoarded black money. It will be a huge profit to the Reserve Bank of India (RBI), a huge windfall revenue to the government, the government can declare moral and material victory and straight and simple but that has not happened; 97 percent of the money has come back. So now we are looking for, at least the government is looking for discovery of black money out of the deposits. In my view, that's got to be at least about 1 percent of additional tax accretion as a result of this otherwise the net cost benefit calculus is negative. It will be like the search for weapons of mass destruction in Iraq, it will be like that. On the second metric about preventing regeneration of black money - that is the continuing effort that government will have to pay attention. In my view in India what is more important than incentives for good behaviour is disincentives for bad behaviour. There has to be a fear of getting caught.Q: Has demonetisation made it worth people to pay taxes because it is such a pain not to pay?A: I would imagine so and I think the government will have to make it worthwhile for them to pay taxes, come clean and come into the formal economy - that\\'s exactly the point I am making that the government has to put fear into them that you will be caught if you are found you are wrong. To some extent demonetisation has set a great signalling impact like the Chinese say you kill the chicken to scare a monkey. So if they follow through this, I think the second metric of preventing regeneration of black money can be pursued successfully.Latha: You are more than just an RBI Governor. You had a long stint in administration; general and economic administration in particular. Did you really need the demonetisation lead audit trail or is the tax administration picking up the available audit trails say in property. We could have caught more black money creators even without this, you think?A: That is a debate we have been going through for the last 30 years. It is not as if demonetisation has been an original idea that has come overnight, right. For the last 25 years every government has been talking about it in most conferences, in most meetings it comes up and then it is discussed and put away as something impractical or inappropriate for that point of time. However, this government bite the bullet. Therefore, I do not believe that you can say that there are alternate methods; there are alternate methods of course but you did need a strong sledgehammer action like this to show the government's determination to get the black money.Q: So, basically, you think there is nothing wrong with this step itself? A: I would think so, yes.Q: The problem lies more in the execution? What is your discomfort, if any with demonetisation?A: Certainly, everybody has talked about the pain and hardship that has gone. Hundreds of millions of people have gone through enormous pain and hardship. People have talked about whether there could have been greater preparedness. We have seen both the government and the RBI back and forth on instructions, confused people. There has certainly been inadequate if also muffled communication. So, all these things could have been done better.Q: Your litmus test, you said, should be at least 1 percent more taxes. You mean 1 percent of GDP? It rises from 11-12 percent or whatever?A: Right. At least 1 percent, otherwise I do not think the cost benefit calculus would be positive. And you must recognise that this 1 percent is on a permanent basis. It is not just this year, but every year. And of course, there will be other benefits of demonetisation like all of this black economy coming into the formal white economy and that having a multiplier effect and the digitisation, etc. and of course, corruption going down.Q: But really, the impact on the RBI is what has also grabbed people’s attention. Do you think the RBI has come out injured in its autonomy and its credibility? That is what many people say.A: Autonomy and credibility are related in one sense and they are also separate. So, let us talk about them separately. Autonomy: to say that RBI’s autonomy has been encroached upon, has been eroded, that is a story that is fed on itself. A lot of people saying this. Where is the hard evidence? You would say that RBI’s autonomy has been eroded provided it has been forced to do something that, in its judgement, is inappropriate to do.What is the evidence people have? People say that the RBI Governor was advised just a day before and the RBI board just took about half an hour to decide. Let us look at them. Just like the army, the army is preparing for a battle for a long time. But the precise time of attack is decided at short notice. That is exactly what happened. The Governor said that they have been in consultation with the government. Both the government and the RBI have been working together for several months. It was advised a day before that this is the time.Second, about RBI board deciding in just about half an hour where this is a matter on which they had to go entirely by judgement. There is no hard evidence, there is no hard data to fall back on. Let me ask you this. You referred to my experience in the government. How long does the Union Cabinet take to improve the Union Budget? Exactly 15 minutes. How long does any State Cabinet take to approve the State Budget? Exactly 10 minutes. This is a matter of record. You can see what time the Cabinet meeting is convened.Q: Yes, but that is only the meeting. They have already looked at several aspects, at least the Finance Ministry has.A: Finance Ministry has, not other ministers. In this demonetisation issue also, the RBI administration has looked at it. The board members have not._PAGEBREAK_ Q: It is quite possible. I am guessing and I have some sources who said so that the RBI did try to point out several problems if and when such a large demonetisation were undertaken. So, they must have, going by my sources, made their points clear that you cannot print. So, to some extent, they were made to do an inhuman feat. No central bank in the world can replace 85 percent of the currency in seven weeks.A: Most of these are not binary issues.Q: So, you do not think that autonomy is hurt. Is that your point?A: I think that issue has been exaggerated. There is no hard evidence to believe that autonomy has been hurt. It is an urban legend that has fed on itself. People saying it and carrying it on. On credibility, it is a different issue. Yes, like we talked about before, to the extent of preparation, to the extent of communication and most importantly, to the extent of some people within the RBI getting caught for wrong doing. That is very hurtful and it has hurt the credibility of RBI. RBI, as an institution has a formidable reputation for its professional and pecuniary integrity and that, I think, has been hurt. It is more a credibility issue than an autonomy issue. You cannot say that the RBI has been forced into it based on the evidence that is now available. Q: What if you were in that position and they gave you six months to discuss, but you were told in seven weeks, 85 percent of the currency has to be changed and you knew the currency printing capacity? What could you have done?A: No, but we are talking about seven weeks now. But the preparation has been going on for a long time. So, when you ask a question like what would you have done, it is a wonderful chance to be boastful. But, when you are in the hot seat there, you do a lot of preparation to the best of your ability, but certainly, on an issue like this, on which there is no experience to fall back on, there could have been some glitches. In the event, I believe that there were more glitches than could have been, but that is par for the course. Yes, people suffered, hundreds of millions of people suffered and we do hope that there will be some significant, substantial and long sustainable benefit out of it.Q: But would you have made your opposition felt?A: Most certainly, yes. I would have told the government of what the state is and if necessary, I would asked for more time. And there is no evidence to show that the RBI or the Governor has not asked for more time.Q: Would you have gone even beyond that and said that I will not be part of it, relieve me because I am unable to do it? How much further would you have pushed your opposition?A: It depends on the circumstances. If I am, in principle, opposed to the judgement on demonetisation, yes, I would have said no. But if it is a question of logistic details, administrative details, that is not a matter of principle on which you sequence.Q: If the logistical problem is so huge as to defeat the policy objective, in that case, which seems to be the case now?A: Yes, but you are talking as if it is all a take it or leave it issues. The government and RBI do not function in that way. Indeed, no two public policy institutions function in that way on take it or leave it business. It is always making your way, convincing each other, persuading each other and compromising in what you believe is the public interest.Q: Interestingly, Dr Reddy said I would have probably got myself admitted to the hospital or in some way, not been part of the proposal on the implementation. Would that be, opting out because of the magnitude?A: I would say, I do not know in what context Dr Reddy made that statement. I have seen reports of that statement. But I would say that if you are, in principle, opposed to the decision about demonetisation, then that is a question for saying I quit. But, if you have some problems on implementation, I do not think that is a matter of principle on which you are required or obliged or called upon to quit. You need to work with other agencies to make it a success.Q: There are only three members of the RBI board, external members. The rest are all RBI Deputy Governors and Governor and Finance Ministry officials. The fact that 6-7 seats are vacant, did all this already pave the way for very weak opposition?A: I do not think so. I think that is reading too much conspiracy into this. There have been several instances over extended period, the RBI board was not fully positioned. At least on the specific point you are referring to that the RBI board is not fully positioned. Yes, that is a shortcoming, that is not desirable, but to see some conspiracy in that and to say that the decision on demonetisation would have been any different or the implementation would have been any different if there had been seven more members on the RBI board is unrealistic._PAGEBREAK_ Q: I will try and recall what Dr Reddy said. He said, I would have tried to convince the government to only do Rs 1,000 notes because that would have been more hadleable and if they did not agree, then I would have perhaps opted out and said, he said I will not oppose the sovereign and be a rebel, I would have quietly said that I am not well and got myself admitted. That was the full statement of what he said. What would, therefore, been yours?A: It is inappropriate for me to comment on what Dr Reddy said, but I told you what I would have done, where I would have stood. If it is a matter of principle, yes, you would stand by your principle. If it is a matter of judgement and you believe very strongly, yes. But if it is a matter of administrative logistics, you try to meet each other, you try to go half way and together, try to make the programme or the project or the decision a success.Q: So, in this case, in principle, you were not opposed to the idea?A: That is a hypothetical question because I do not have all the facts, all the judgement, all the analysis that was done when demonetisation decision was taken. So, being outside now to say that I would have approved demonetisation or I would have disagreed with it, is completely hypothetical.Q: What about the way RBI itself has handled the communication? Would it have been better if RBI had admitted, taken the public into confidence, more communication would have saved the RBI more credibility?A: Abstracting from all the specifics that you are talking about, about deadlines, dates, printing capacity because I am not familiar with all of that, it certainly would have helped if RBI had been more communicative and RBI had been seen to be in command of communication, not yielded to the government or other agencies. I wrote about this in my own book. I had a similar handicap. When I came in, the global financial crisis erupted and there was criticism in the early weeks and early months when I came in that I was not being sufficiently communicative. Some of you, including probably yourself said that and I have corrected for it. So, I think RBI should have been in the driving seat as fast communication is concerned because this is an issue that is squarely within the RBI’s domain and should have been more communicative and should have been seen to be in command of the situation.Q: One more word on Dr Reddy because I recently met him.A: You must ask Dr Reddy about Dr Reddy.Q: No, I will tell you why. In your book, you quote Dr Reddy and you said that I am not able to remember the quote very well. The RBI is autonomous and before I came here, I took my Finance Minister’s permission to say so. But in your book, you do not quite agree with them. You said that is a clever way of evading the issue or something. Do you think the RBI is not really all that autonomous?A: First let us come to the comment. I said it is clever but it is incomplete because what is the boundary defined by the government. It is unclear both to the government and to the public who make a judgement. People such as yourselves, who manage opinions, manage perceptions, many of them do not know and it is not just unique to India. Everywhere it happens. It has happened in America, it has happened in a big way in Japan between Prime Minister Abe and previous Governor Shirakawa. So, it is not unique to India, the autonomy issue. The RBI should be autonomous. In respect of issues in which it is statutedly given autonomy such as monetary policy, regulation of financial institutions, financial markets, payment systems, it should be autonomous, yes.Q: What of the future then. What can RBI or government do to perhaps improve the credibility that has taken a beating if you go by statements made by the economists or Standard & Poor. International agencies have said RBI's reputation is in tatters?A: But we must go behind. As we discussed earlier, RBI's reputation, RBI's record or credibility is an issue different from RBI's autonomy. We are talking about autonomy, right. So both on respecting and preserving RBI's autonomy as well as RBI's credibility both the RBI and the government will have to be working on this. However, having worked both in the government and in the RBI, I can say that there is insufficient sensitivity in the government to RBI's autonomy. They must do several things, for example as far as RBI's policies are concerned where the RBI statutorily has autonomy; the government can comment but should comment cautiously, sparingly and with wisdom. I will give a simple example, if the finance secretary or the finance minister says that I expect the RBI to do this - that sends a different message from saying I want RBI to do this. The Confederation of Indian Industry (CII) or the Associated Chambers of Commerce and Industry of India (ASSOCHAM) or the Federation of Indian Chambers of Commerce and Industry (FICCI) don't say I expect the RBI to do this. They say we request to do this, we want the RBI to do this, we would like if RBI does this.Similarly the government as a stakeholder can certainly say the same thing but to say that we expect the RBI to do this - sends a different message, but just another thing because we have raised this issue, you were there at the panel discussion on my book when Mr. Chidambaram was also there and Mr. Chidambaram made the point that the RBI is a public policy institution. When an institution makes public policy, everybody has a right to criticise so does the government; government has a right to criticise. I do not completely agree with that. Government criticising the RBI in a public forum is detrimental to macroeconomic management. So the government can certainly advise RBI behind closed doors but should not criticise the RBI in public domain. It's the sovereign and it is a very asymmetrical relationship. People know that if the government criticises, there is also an encroachment into RBI's autonomy at least that is the perception that people will get and that is not a healthy perception to push through.Q: Looking at the future, we have the Budget coming in a few days. The expectation is that because demonetisation caused pain the fisc should make good. What do you think should be the fisc's responsibility in this Budget?A: I have a very definite view on this. I am a fiscal hawk and for good or bad the fiscal responsibility of the government is seen to be the bellwether indicator of its reform credentials. This is not just for this government, for several governments for the last 25-30 years this has been the case. We saw it in 2015 when finance minister Jaitely deviated from fiscal responsibility; there was a lot of criticism. In 2016 when he confirmed to it, there was a lot of praise. Domestic investors, foreign investors, analysts, commentators, opinion makers, all of them attached a lot of weight to this. So I do not believe that deviating from fiscal responsibility is a wise thing and where is the case for it. If after all the government and the RBI are actually saying that this is a temporary blip, we could have a v-shaped recovery, there is going to be no hysterias at all, there is a temporary demand shock; where is the case for any fiscal stimulus, in fact I would argue that if you indeed get additional taxation and spend that money - there will be additional demand and there is no case for fiscal stimulus and there has already been a lot of monetary easing as a consequence of deposits and all that. So both from perception point of view as well as from hard macroeconomic evidence the case for deviating from fiscal responsibility is zero.