The current RBI-government relationship was the result of a broad intellectual consensus that was based on evidence in the Indian context and defied easy ideological classification
Avinash M Tripathi
In my last article for the Moneycontrol, I wrote the following about the Reserve Bank of India (RBI) and the government’s relationship: “As the current level of stress in the relationship suggests, the autonomy that is based on norms and conventions is fragile; it may break down in the times of turbulence, precisely when it is needed the most.” Little did I realise that the ‘times of turbulence’ will arrive so fast. Since then, RBI governor Urjit Patel stepped down and Shaktikanta Das has been appointed the new Governor of the central bank.
The decision to step down is the culmination of a number of other worrying developments. In their seminal work on the central bank independence, Alex Cukierman and his co-authors found that the simplest proxy for central bank’s operational autonomy is the central bank governor’s turnover rate.
A longer tenure of the governor, which implies lower turnover rate, is associated with the greater autonomy which in turn predicts reduced inflation. The tenure of the last two governors, Raghuram Rajan and Urjit Patel, was effectively three years and two-and-a-half years respectively, which is significantly shorter than their global peers and immediate predecessors.
Besides the shorter tenure, the recent period also witnessed black swan events such as the shuffling of the RBI board, invocation of the extraordinary provisions of the RBI Act, and a proposal to let the board move beyond its current advisory role.
If the invocation of extraordinary provisions risks making the central bank an extension of the finance ministry, the proposal to give the board more activist role may potentially recast the RBI into a political body, something like the erstwhile Planning Commission. This is worrying as one of the roles RBI performs is to provide a sense of continuity and stability in the times of political uncertainty.
Some have argued that since Indian economic conditions substantially differ from the global realities, the global template of the central bank autonomy cannot be replicated in India. This argument is misleading and ignores the lessons of the Indian economic history. In fact, the RBI’s arms-length relationship with the government is the result of an organic and indigenous evolution, not just an imported fad. A candid look at this history may be useful.
CD Deshmukh, who served as the finance minister for the longest period in Nehru government, was respectful of RBI’s independent functioning, despite some policy disagreements. The defining episode that reset the relationship between the government and RBI was the resignation of its fourth governor B Rama Rau, after his tussle with the then finance minister TT Krishnamachari.
The resignation of Rama Rau had far-reaching consequences. The official history of RBI notes that after this resignation, it was ‘impossible not to detect change in the tone of the Bank’s relationship with the government’. Later governors understood their place in the pecking order and got acclimatised to it. The watchdog that was supposed to bite on occasions stopped even barking.
In practice, this meant printing as much money as the government of the day demanded. Some such as LK Jha even went to the extent of arguing that ‘RBI was bound to finance the fiscal deficit of the government’. Not that the government needed the approval of the RBI to monetise its deficit in the first place. One temporary overdraft facility called ‘ad hoc treasury bills’ became a perennial source of money creation.
Inevitably, inflation persistently remained near double digit, at its peak even crossing 20 percent. Even those high figures were probably underestimates, as most of the prices were controlled and not market determined.
Finally, after 1991 reforms, the fiscal dominance was tempered by a seemingly independent central bank. Even though the concrete details were chalked out by policymakers such as Manmohan Singh and C Rangarajan, at least part of the intellectual spadework was done by Sukhamoy Chakravarty, not exactly a Chicago school economist.
As we are about to repeat history, it is worth recalling that the current RBI-government relationship was the result of a broad intellectual consensus that was based on evidence in the Indian context and defied easy ideological classification.
For someone criticised for being uncommunicative, Urjit Patel has crafted one of the best metaphors for the central bankers. When asked whether he was a hawk or a dove, he replied: “We are neither hawks nor doves. We are owls.”
In the Indian tradition, an owl is the vehicle of Goddess Laxmi, the presiding deity of wealth and prosperity; in the western tradition, an owl symbolises vigilance and wisdom. All these are the key attributes of a good central banker, yet his abrupt departure may have added a new nuance to an already overloaded metaphor. As Hegel once said, the owl of Minerva takes its flight only when the shades of night are gathering on the horizon.
(Avinash M Tripathi is associate research fellow (economics) at Takshashila Institution. Views are personal)For more Opinion pieces, click here.