Back to basics: Conflicts arise when governments set aside long-term goals for short-term gains
Central banks are government banks. Their objective is to govern monetary policy, which essentially means controlling the amount of domestic currency circulating in the country’s economy at any point of time.
Other objectives include: managing and disbursing liquidity in the system, exercising supervision on the nation’s exchange rate and foreign exchange reserves, and having a regulatory oversight on the nation’s banking sector to ensure their overall solvency and stability.
A competent central bank ensures that it helps the nation achieve low inflation and commensurate interest rates, cushion economic cycles from the vagaries of political ups and downs, and thus boost fiscal stability and discipline for sustained economic growth. And to do all this, a central bank needs autonomy.
A central bank is said to be autonomous in so far as it is able to carry out its responsibilities without undue pressures and controls from the executive and the legislature. In general, in most mature democracies, at least in form, politicians do cede authority over money supply to the central banks. If they didn’t, political compulsions and whims can speedily result in serious inflationary shocks in the economy, leading to imminent collapse of the economy, as has been seen in many totalitarian regimes in the past.
Today, the need for central bank’s independence is so well recognised that it does not merely imply a central bank exercising its independence. It means a government proactively creating an environment in which its central bank would be independent. It means recognition of the fact that though a central bank may not be a constitutional arm like the executive, legislature and the judiciary, its independence, like that of the Election Commission, is no less paramount.
The parameters of the Reserve Bank of India’s (RBI) autonomy are well known: appointment of the governor and the tenure; appointment of the RBI board and its tenure; degree of executive interference in its governance; independence from executive nod in formulating and carrying out monetary policy and necessary checks and balances that strengthen the institution of the central bank in cases of conflict with the executive.
To the credit of our successive governments as well as the RBI, it must be said that by and large, the central bank’s independence has been respected and exercised. The tug of war for autonomy between the two never reached a breaking point. This is not to say that every now and then situations will not arise, as it has now, and these are the occasions when the RBI ought to actively push back to preserve its autonomy.
In the present context, it would be unreasonable for anyone to hold the view that the executive ought not to have thought of demonetisation as a tool in its fight against black money and terror financing, to fulfil its desire to bring all cash transactions under the fold of banking, and in its bid to take the economy towards a greater degree of digital transactions.
Each objective is laudable and worthy. If so, by merely seeking the RBI’s cooperation in translating the objective of demonetisation into action, can the executive be said to have breached the RBI’s independence? Hardly.
Nor can it be anybody’s case that a central bank is not independent unless it is at loggerheads with the executive. Can we say the independence of the RBI has been compromised merely because it agreed with the government on demonetisation? Certainly not. That is, not if the RBI had deliberated on the question sufficiently and adequately before agreeing with the government on the merits.
If the credibility of the RBI seems to have suffered a setback in the course of demonetisation move, it is because of the incumbent governor’s confession to the Parliamentary Standing Committee that the government had “advised" it [RBI] to scrap Rs 500 and Rs 1,000 notes on November 7..., his long silence after November 9 and the slipshod implementation that reeked of lack of preparation which gave further credence to the perception that the RBI had been caught by surprise.
After all, sustained governmental pressure on the previous governor, Raghuram Rajan, for reduction of interest rates was also intense. But, as the ultimate arbiter of monetary policy of the country, Rajan protected the RBI’s autonomy vigorously. Some may argue that this was also a reason for not extending his term, but we never said extension of his term is one of the governor’s stated or unstated objectives. Of course, Rajan was not the first central bank chief in the world who paid a price for being a tough interest-rate chief. The question is, did his successor Urjit Patel do enough - or rather anything at all - to protect the bank’s autonomy?
Controlling the amount of domestic currency circulating in the country is what control of monetary policy – the primary objective of any central bank – is all about. And here was an “advice” from the government to suck away 86% of the money supply from the economy overnight to solve three or four different problems. Did the RBI diligently deliberate upon the government’s proposal before going with it?
Choices RBI had
The only possibilities before the RBI would have been the following:
a) agree with the strategy as well as the implementation after due deliberations. If this was diligently done, the botching up of the implementation is a burden that the RBI must carry upon its shoulders. In such a case, the issue is not so much of independence of the RBI as of its incompetence.
b) agree with the strategy but not with the timing and the rollout plan. If so, the central bank seems to have done little to stand its ground. This is where the RBI seems to have entirely failed to even try to assert its independence.
c) Not agree with the strategy as a single pill for four different maladies, and present an alternate strategy plan of its own, which of course has not been the case.
So in any scenario, it appears that at the very least, the RBI governor has been either incompetent or weak or both. It is this impression that seems to be a matter of concern to the staff and some of the past governors of the RBI, and which has taken a bit of its sheen.
The question ultimately boils down to this: as a professional, do I serve a boss better by providing him the opinion he wants to hear or by providing him the opinion he ought to hear? The central bank’s autonomy is about the latter.
(The writer is former president of ING Vysya Bank and a former professor at IIM-Ahmedabad)