This Article is From Jan 23, 2017

Modi's Takeover Of The RBI And Where It Has Left Us

The renowned historian, Prof. Satish Chandra, in his magisterial work, Medieval India (1206-1526), quotes Ibn Battutah who visited the court of Muhammad bin Tuglaq as saying the ruler's gravest fault was that he "depended on his own judgement and rarely took advice from others."

Cut to the 21st century and one could say the same about Modi, especially as Modi's demonetization drive has been so accurately described by Mihir Sharma, in his Bloomberg View on this site, as a "foolhardy exercise in pointlessness", as foolhardy and pointless as Tughlaq's experiment with copper coins, withdrawing gold and silver as legal tender without adequate prior preparation and replacing these with copper and brass, then reversing his orders and thus bankrupting the Treasury. (However, history does not record Tughlaq having issued orders, and orders to reverse orders, 138 times in 70 days as the Modi regime has done!) The IMF have just shaved one percent (Rs 1.5 lakh crore) off their estimate of India's GDP growth rate for the current fiscal year, while Dr. Manmohan Singh sticks to his estimate that the fall-off will be nearer 2-3%, or Rs 3 lakh crore to Rs 4.5 lakh crore.

And to what end? Tughlaq thought he could raise funds to fight his wars with Iran and China by demonetizing gold and silver. Modi thought he could end "black money" by rendering "high denomination notes" invalid. Both were wrong because they would not take advice. If only he had cared to ask his own Finance Minister, Modi would have learned that "black money" in cash constitutes no more than 5-6% of cash in circulation and, therefore, it would be as foolish to target 86% of cash in circulation and 98% of all economic and commercial transactions to find the needle in the hay-stack as it would be to shift the capital from Delhi to Daulatabad by forcing all Delhi dwellers to move, killing a blind man who said he could not find the way and compelling the lame to drag themselves hundreds of miles on one foot, leaving behind not a dog to bark or a cat to mew. (At least 120 people have died in direct consequence of demonetization.)

It is precisely to prevent such playing around with the economy's lifeblood - currency - that in modern times, central banks have been increasingly given real autonomy, freedom, and independence to manage the nation's currency. That is why the Reserve Bank of India Act, 1934, describes the RBI's "basic function" as: "to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantages."

The point to note is that "operating the currency" is not the function of the Government of India. It is a duty enjoined on the RBI and the RBI alone.

An IMF Working Paper (WP/07/88) by Marco Arnone has elaborated the fundamental features of the central government-central bank relationship as including autonomy in setting the policy rate; not extending direct credit to government; exercising financial supervision; and ensuring the soundness of the financial system. This requires governing bodies of central banks to be inured from political interference by minimizing government's role in appointments to the governing body and giving members longer terms. Indeed, it stresses the basic consensual "autonomy" principle that "government participation in a policy-making board is not necessary".

The Working Paper goes on to construct an index of central bank autonomy for 163 countries, divided into three categories: "advanced"; "emerging" (in which India falls); and "developing". "Political autonomy" is indexed separately from "economic autonomy" and then combined in an "overall" index of autonomy. Total autonomy scored 1.00; no autonomy scored 0.00. The data related to 2003.

As of that date, the "political autonomy" of RBI was rated at 0.25, just under half the average "emerging economies" score of 0.56. (Extraordinarily, Iraq under Saddam Hussein scored twice as high as India!), but on "economic autonomy", India scored a high 0.75, just below the "developed" average of 0.81. Thus, we were not perfect, as shown by the run-ins that RBI Governors D Subbarao and YV Reddy, to name but two, had with their respective Finance Ministers; but greater autonomy for the central bank was moving in the right direction. The Working Paper establishes a pretty strong correlation between the extent of central bank autonomy and the stage of development of the economy - the more independent the central bank, the better the overall performance of the economy. Former RBI Governor Raghuram Rajan is on record as saying that independence of the central bank is "essential for stable sustainable growth". Another former Governor, Bimal Jalan, in his interview to The Indian Express (14 December 2016) has held RBI autonomy to be "a very fundamental fact".

Modi's actions on and after 8 November have seriously called into question the autonomy of the RBI and thus seriously damaged both the present performance of the economy as well as its future prospects. Amartya Sen has been blunt to the point of cruelty: "I don't think RBI decides anything at this time". Former Governor YV Reddy has stated forthrightly that had he been presented with such an ultimatum, he would have resigned rather than carry out such instructions.

What was the sequence of events leading to the decision to demonetize nearly nine-tenths of the currency in circulation? When, if ever, did the Prime Minister's Office consult the Finance Ministry or NITI Ayog? If it did, what was their view and was it deliberated on in cabinet or the relevant cabinet sub-committee? Indeed, is it not a fact that PMO issued its "advisory" to RBI of 7 November of its own sweet will, without consulting anyone else? Is this in accord with Section 7 of the RBI Act that sets out the terms and conditions for Government to issue directions to the RBI where this is established as "necessary to the public interest"? Was there any such necessity? For, after all, as former Governor Bimal Jalan told the Indian Express (14/12/16), "When you demonetize legal tender, there must be a very good reason for it. War, security threat." Was there a war on? And as for any perceived "security threat", now that we have three different types of Rs. 500 notes with no new security features and the ink runs off the note, has demonetization ended or promoted "fake notes" bruited around by Modi as a major security threat?

Moreover, says Jalan in the same interview, there was "no reason to be secretive" - and so blows away the excuse behind which the government has been sheltering to explain why less than 24 hours was granted to the RBI to consider so economically disruptive a step, the initiative for which, if necessary in the public interest, should have come from the RBI as the Keeper of our Currency, and not the central government. Also, is it not true that only 8 out of 21 members of the RBI Board (half of whom were government nominees!) met on November 8 before Modi went on the air, one reason being Modi's deliberate and continuing delay in filling vacancies on the Board? And why have the minutes of the Board meeting not been placed on record?

Instead of Governor Urijit Patel demonstrating any transparency in the matter, the RBI has actually taken the stand on a Right to Freedom of Information request that bringing it all into the public domain might jeopardize the very lives of those involved! What is this - some kind of B-grade Bollywood movie? No wonder the United Forum of Reserve Bank's Officers and Employees has written to Urjit Patel on 13 January that "operational mismanagement" has damaged the RBI's autonomy and reputation "beyond repair". Truly, the wearer knows best where the shoe pinches.

Does any of this square with the Finance Ministry's claim of 14 January 2017, that "the government fully respects the independence and autonomy of the Reserve Bank of India"?

If the IMF were to update their 2003 paper on central bank autonomy, India would fall precipitately from a relatively honourable position to the bottom of the heap. We now rank with Zimbabwe on autonomy. The Modi-Patel duo would be well advised to remember what John Maynard Keynes - the great Keynes - said: that the surest way of debasing a country is to debase its currency. That is the measure of the tragedy that has befallen us.

(Mani Shankar Aiyar is former Congress MP, Lok Sabha and Rajya Sabha.)

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