The taming of a central bank
India's factor markets are broken. Land acquisition is next to impossible. Labour market reforms are threatened by a coalition of international agencies and mollycoddled labour unions. Banks have dud assets on their books and their nodal ministry appears to be waking up to their problem after about 14 months in office. Economic growth numbers are still not convincing. In this milieu, some officials in the finance ministry decided it will serve national interest best to put up the revised draft Indian Financial Code on the website for comments.
Commentators and media did not have time to plough through the code. But, they cottoned on to the fact that a section of it seeks to rein in the powers of the governor of the Reserve Bank of India (RBI) with respect to the conduct of monetary policy. That was enough for them to paint the finance ministry in one corner and RBI in another.
More precisely, it was painted as a battle between the finance minister and the incumbent RBI governor. Some commentators took one look at it, thought for a second about which side of the fence they were on and took sides on that basis. There was a focus on the short-term, sensationalism, personalities over prin- ciples and wrong framing of issues. It was the quintessential Indian approach to problem solving.
Laws governing the conduct of macro-economic policy and the financial sector will be with the country well beyond the present gov- ernment and the present RBI governor. Framing the issue as one of a battle between the finance minister and the RBI governor is myopia.
It was the United Progressive Alliance (UPA) government that appointed the Financial Sector Legislative Reforms Commission (FSLRC) in 2011 and that commission came up with the code. It is not an initiative of this government. This government had good reasons to abandon the work of the commission and start afresh. But, as with many other things, it has decided to carry forward the worst policy legacies of the previous government.
The real purpose of the code appears to be as much about unleashing the financial sector-global and Indian-on the unsuspecting Indian public as it is about constraining the central bank from stopping that process. However, even if the authors of the code have taken on the mission of taming RBI, the ministry should realize that there are more urgent and important priorities.
Indeed, a non-transparent and relatively opaque central bank appears to be ideally suited to prevent the emergence of the financial sector that drives the real economy than the other way around. India did not have the problem of an overarching financial sector in 2008 because, as Joe Nocera put it in a New York Times article in December 2008, "the Reserve Bank of India had a bank regulator who was the anti-Greenspan and that his name was Y.V. Reddy".
Greenspan, the apostle of financial de-regulation, admitted that he had found a fatal flaw in his model. He elaborated further on his confession in a conversation with journalist Gillian Tett of the Financial Times at the Council on Foreign Relations in October 2014. He said that nonfinancial sectors were well behaved and that animal spirits run wild in the financial sector. In effect, he admitted it could not be left to its own devices. Of course, the empirical proof was the crisis of 2008. Given freedom to choose their own leverage (capital) ratios, financial institutions did not manage their risk and made the system risky and unstable.