Thursday, January 19, 2017

Has demonetisation compromised RBI's autonomy?

I don't think so, contrary to what many have been saying.

Here's the link to my article in BS, Much ado about RBI autonomy.

As the article is behind a pay wall, I reproduce it below:

Much ado about RBI autonomy

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 the 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. The RBI has outlined the sequence of events in its response to Parliament’s Standing Committee on Finance. The government advised the 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 the RBI’s critics- here's proof that the decision to demonetise was that of the government and that the 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 the RBI might have done a better job of implementation.   Maybe the 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 the 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 the 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.

2 comments:

Raghav said...

If your point is that RBI never had the autonomy and as such it only existed in text books, I think you have a fair point. As you have pointed out, Dr Reddy has correctly said that the recent attempt to undermine the RBI started well before this Government took over. It happens often in our country, if the Government feels that the Election Commissioner has risen in stature 2 more are appointed and a Commission made out of it. So what has changed now?
When the media talks of central bank autonomy in our context it not talking so much about the legal autonomy (which does not exist) but about the intellectual autonomy which the central bank is expected to have and till this recent demonetization, RBI had demonstrated to some extent. It's past Governors, even when they came from the Government, displayed at least an intellectual honesty that seems to be missing now. Really, if the RBI has to hire a Stern School professor to communicate for it, the competency of RBI is in question in many more areas than just in distribution of currency. The silence of the RBI hurts the Government as much it hurts the RBI.
Your argument about letting off the Board because, "almost unheard of..." doesn't cut ice because by the same argument, we should be electing only one Prime Minister because the entire parliament (atleast all his parliamentarians) agree with him, just as independent board members 'largely' agree with the CEO but flawed as they may be they are the bedrock of a democratic country.
Basically, this is a botched up operation, nobody can deny. Either we agree that the RBI is incompetent Board down or we assume that the Government did not let them to function the way they would like. There is no third option.

Prabhat Singh said...

This comes a tad late, but I have reservations against some of your claims:

1. You say a fully staffed board couldn't have resisted the governor, just as a company's board can't resist its CEO.

- Firstly, company boards are meant to resist the CEO's whims. The fact that they can't is an indicator of poor governance, and shouldn't be used as an excuse to allow the same at RBI. The board is an important body of RBI and has several sub-committees which look after very important functions including financial stability. Secondly, if BoE's MPC could go against its governor's wishes in 2013, there's reason to believe that an autonomous, empowered RBI board can also do the same. Moreover, as claimed by a former RBI deputy governor, UPA II's request for demonetisation was rejected by RBI even without its reaching the board level.

2. Even if deliberations on demonetisation were going on since Jan 2016, as claimed by RBI governor, it's safe to say that only a very small number of RBI officials, and certainly not the whole board, knew about it. This means that the board as a whole was indeed presented with this mega proposal on Nov 8, and it took no time to clear it. Doesn't smell right to me. Moreover, even the cabinet had no idea about this till the very last moment, and their approval was nothing but rubber stamp.

3. "Whether demonetisation...general election"

- What? This is exactly what lets governments inflict wanton misrule on the people as soon as they takes power. Why, then, have any checks at all, if everything has to be decided at the next election? Sounds like we could abolish CAG, SC etc. and let elections decide everything.

4. The govt and RBI have stonewalled every RTI query demanding transparency. We don't know which meeting of the central board led to the decision to introduce Rs. 2000 and the new Rs. 500 notes. Why not make minutes of central board meetings public?

5. The last para makes a lot of sense. Maybe it's sensible to reduce RBI's powers. But that should mean separate institutions that are in themselves autonomous and empowered, instead of govt simply usurping all powers, which is what has been happening so far.