Much ado about RBI autonomy FINGER ON THE PULSE

These are not the happiest of times for India’s central bank. The Reserve Bank of India (RBI) has faced unprecedented criticism over its handling of the demonetisation of high-value currency notes.

Some allege that the RBI governor and its board of directors caved in to pressure from the government. Others contend that RBI stumbled on implementation. Yet others see the episode as another sign of the Narendra Modi government’s penchant for undermining the autonomy of institutions. The critics are getting carried away.

Let’s begin with the decision to demonetise. RBI has outlined the sequence of events in its response to Parliament’s Standing Committee on Finance. The government advised RBI of its intention to demonetise on November 7. The RBI Board met the next day and approved the measure. This was followed by Prime Minister Modi’s address to the nation. Aha, say RBI’s critics — here's proof that the decision to demonetise was that of the government and that RBI tamely fell in line.

Not so fast. It’s not as if the advice on demonetisation was sprung on an unsuspecting RBI. Reports in the media indicate that the sequence mentioned above is not the whole story. It relates only to the formalisation of the decision to demonetise. It had been preceded by consultations on the subject during the tenure of the previous governor, Raghuram Rajan. These consultations are said to have commenced as early as in May-June 2016.

Nor is there reason to believe that RBI management had reservations about the decision or the timing of it. RBI has told the Standing Committee that last November when it was presented with the government’s advice on demonetisation, it felt that the time was opportune as it coincided with the planned introduction of a new series of notes.

Let’s turn now to the role of RBI’s central board of directors. Critics say that the board failed to satisfy itself about the decision and its likely impact. They point out that that since a large number of non-official positions on the board (ten, according to some reports) have not been filled, the board was not well placed to take an independent decision in the matter.

If the suggestion is that the board of RBI could have stopped the government from going ahead with demonetisation, it is completely untenable. Any decision to demonetise is the prerogative of the government- and the government is accountable to Parliament and the people.

Whether demonetisation was an unsound decision and whether it caused economic dislocation without any compensatory benefit are matters that must be decided at the next general elections. It is not for the RBI board to judge. At best, the RBI board can satisfy itself that the government’s advice in the matter does not constitute any infringement of the RBI Act.

It is also not true that an independent RBI board can overrule the RBI governor in such a matter. The position of the board of directors of RBI in relation to the Governor is not the same as that of the board of directors of a company in relation to a CEO -and we all know how good corporate boards are at standing up to the CEO despite the fiduciary obligations that board members have.

It is almost unheard of for the board of RBI to oppose the governor or even to actively question the Governor’s decisions — most members would not even be competent to do so. In practice, the board of RBI is a sounding board for the Governor. It can provide advice or feedback but it does not overrule. The idea that a fully-manned RBI board could have somehow resisted the government’s advice on demonetisation verges on the ludicrous.

It’s possible to suggest that RBI might have done a better job of implementation. Maybe RBI could have ensured that there was an adequate stock of ~500 notes. Maybe it was unwise to issue ~2000 notes. Given time and better planning, the dislocation might have been better contained. But all this is sheer speculation. We don’t know whether better planning would have been consistent with the need for secrecy. And we don’t yet know the extent of dislocation caused either.

Former RBI governor Y V Reddy thinks RBI could have done a better job of communicating with the public as demonetisation unfolded. He suggests that if a governor is not comfortable communicating himself, he should let one of his deputies do so. This could be useful advice for the reticent Urjit Patel who will soon acquire an articulate professor from Stern School of Business as his deputy.

Demonetisation hasn’t quite evoked the public anger its critics had hoped for. It does appear that they have latched on to the supposed erosion of autonomy of RBI as an instrument for Modi-bashing.

The challenge for RBI is not any erosion of autonomy caused by demonetisation. It’s the whole attempt to reduce the stature and role of RBI that has been under way consequent to the report of the Financial Sector Legislative Reforms Commission submitted in March 2013. The attempt commenced in the time of the United Progressive Alliance government and has merely continued under the present government.

The moves to create an independent agency for public debt, hand over the supervision of the government bond market to Securities and Exchange Board of India and give statutory powers to the Financial Stability Development Council are all part of a larger design to cut RBI to size. The RBI governor used to head the panel to select a deputy governor. He is now a member of a panel headed by the Cabinet secretary.

Resentment of RBI’s stature runs deep in the political class and the bureaucracy — and it has nothing to do with the complexion of a particular government. Dr Reddy is right in urging a national debate on the role of RBI.