Who will regulate the regulators?

Regulators set standards for others. What about the standards at the  Statutory Regulatory Authorities (SRAs) themselves? 

This is one issue that has come to the fore following the current controversy involving the Chairman of SEBI. What are the disclosure standards for the SEBI Chairman? How well are potential conflicts of interest handled? We had news today that SEBI refused to provide the Chairman's list of recusals in response to an RTI query- the news occasioned much outrage in the social media.

K P Krishnan, a former secretary in the finance ministry, has raised the issue of accountability of SRA such as RBI and SEBI in a recent article. 

The legislative actions of the SRAs are supposed to be subject to legislative scrutiny. The record on this point is disappointing:

Over a 23-year period, between 1999 and 2022, the Lok Sabha parliamentary committee reviewed 13 regulations issued by all SRAs, and the Rajya Sabha parliamentary committee reviewed four such regulations. Sebi alone has issued more than 650 regulations since it came into being. There are more than 20 SRAs at the level of the Union of India, and most of their legislative activity is not being subject to parliamentary scrutiny

There are limits to what parliament can scrutinise. Much responsibility must devolve on the boards of directors of these institutions. Here again, the record is pathetic:

The composition and functioning of the governing boards of all SRAs in India leave much to be desired. They are almost entirely composed of internal persons and serving government functionaries. In practice, the board delegates most of the powers to the chairperson and provides very little oversight. There is a striking gap between the governance standards that Sebi demands of listed companies or the Reserve Bank of India (RBI) demands of banks and  how Sebi and  the RBI themselves are governed.

Krishnan makes two excellent suggestions. One, there must be a separate parliamentary committee to monitor SRAs. Two, the Comptroller and Auditor General (CAG) must undertake performance audits of the SRAs instead of confining itself to financial audits. 

These reforms are necessary. What is missing in SRAs today is democratic accountability, an imperative for any public institution. 

Forex reserves and RBI intervention

I pinched myself in disbelief when I saw a news item that said the RBI may have BOUGHT $8 bn dollars in the market in the past month. 

So the RBI is causing the dollar to strengthen vis-a-vis the rupee, meaning it wants the rupee to depreciate In the previous months, the RBI had been doing quite the opposite- it had dipped into its forex reserves to SELL dollars in order to contain the depreciation in the rupee. As a result, India's forex reserves fell by about $ 85 bn in the period April-September 2022. 

But that was not entirely because of sale of dollars by RBI. Dollar sales are said to account for about a third of the decline in reserves. The rest of the decline was because of revaluation of reserves. The RBI holds large amounts of bonds in foreign currency, especially US Treasury bonds. These holdings have been falling in value thanks to rising interest rats.

As you know, we've had people howling about RBI's market intervention. Many were worried about the fall in our forex reserves. They said: why intervene? Let the rupee fall. It would be good for exports. 

The RBI Governor gave a fitting response recently. About the fall in reserves, he said that is what the reserves are meant for- for a rainy day. They are not, he said, meant to be a 'showpiece'. As for export growth, I doubt that rupee depreciation will do much to help in the current situation. The export markets are down, so it's unrealistic to expect a big boost to exports. Our major imports, such as oil, as price inelastic, so imports will shoot up with rupee depreciation. Chances are BoP will worsen, not improve, with rupee depreciation. 

That apart, it makes no sense to let the market dictate the exchange rate entirely. It may dictate the direction of the exchange rate but not the magnitude. The RBI is committed to containing rupee volatility. It has an unstated objective, namely, containing the Real Effective Exchange Rate (REER) of the rupee within a band of plus or minus 5 per cent. Excess volatility in the exchange rate makes investors jittery. 

Net portfolio investment flow into India  turned hugely positive in August reversing the trend of the previous months. It turned negative in September and October but has turned positive thus far in November. If portfolio investors sense that the rupee is in a free fall, they will head massively for the exit, causing the rupee to plunge. Rupee volatility must always be managed.

I wonder what is going to happen to the forecasts of the forex pundits who saw the exchange rate headed towards Rs 85 to the dollar or even above that. The rupee is now less than Rs 82 having touched Rs 83 on October 19. The trend has reversed in recent weeks. Inflation in the US has begun to respond to earlier rounds of tightening. There is a sense now that the Fed may not have to tighten as much as thought until now.  

Overshooting of exchange rates is a well-established phenomenon. There are periods when the rate goes above or below the equilibrium value before returning to equilibrium. Some of the depreciation we have seen in recent months falls in the category. The necessary correction may be happening, helped by perceptions about future rate moves in the US. As interest rates in the US correct downwards, the value of US Treasuries will rise and with that India's FX reserves.

I wouldn't be surprised if the exchange rate at the end of FY 22-23 is closer to Rs 80 than to Rs 85.( Caveat: I'm assuming no serious escalation in the Ukraine conflict).  I won't be apologetic if I'm proved wrong: the tribe of economists has long claimed a divine right to be wrong in its forecasts. 

 

RBI and government of India differences?

The RBI put out a paper on bank privatisation in the RBI Bulletin..  The paper argued that public sector banks (PSBs) have done better on financial inclusion that private banks. It also found that counter-cyclical policy happens better through PSBs, no surprise as they are subject to broad government direction.

On these grounds, the paper argued that 'big bank' privatisation is not desirable, we must hasten slowly. Somehow, the seems to have got interpreted in some quarters as anti-privatisation. The RBI was constrained to issue a clarification. The RBI said the paper does not reflect the views of the RBI. It also said that "instead of a big bang approach, a gradual approach as announced by the Government would result in better outcomes", which is correct. 

Any controversy over the paper is entirely avoidable. 

There is another issue, however, on which there appears to be a difference. The RBI put out a discussion paper seeking views on the question of charging for UPI payments. The government clarified promptly that "UPI is a digital public good with immense convenience for the public and productivity gains for the economy. There is no consideration in Govt to levy any charges for UPI services.".

Should central banks prioritise inflation or growth this year? No easy answers

Central banks in advanced economics cannot make up their minds whether they should priortise growth over inflation in the months to come. That is because it's hard to predict how the Ukraine conflict will shape. 

At the moment, they have prioritised inflation. But if the conflict worsens, growth will be the bigger problem. My column in BS today, Central banks haven't got it wrong.

FINGER ON THE PULSE

Central banks haven’t got it wrong

TT RAM MOHAN

Central banks in advanced economies are today in thrall to the conflict in Ukraine. Emerging market central banks, in turn, are in thrall to the actions taken by the US Federal Reserve. Those who fault  central banks for their response to inflation in recent months seem to gloss over these facts.

During the global financial crisis of 2007, central banks knew what they had to do- loosen monetary policy and keep doing so. Likewise, during the pandemic. Now, the course is nowhere as clear.

The conflict in Ukraine has rendered the conduct of monetary policy extremely difficult. There is still no knowing how the conflict will pan out. Western sanctions against Russia are unprecedented in their scope and severity. And it’s hard to say how Russia will respond as the conflict rages on. 

The US Federal Reserve faces an unenviable task.   With the inflation rate in the US at 9.1 per cent in June, analysts warned  that a recession was imminent.  Some claim that the US is already in recession. This would imply that the Fed should go slow on rate hikes to fight inflation.

Hold on. After the last meeting of the Federal Open Markets Committee, Fed  Jerome Powell poured cold water on talk of a recession. US unemployment rate in July was 3.5 per cent, which was the level before the pandemic set in. This meant that the Fed should tighten more aggressively, not less so, as the recession school contended.

If that is not confusing enough, the conflict in Ukraine is a huge imponderable. Do we know whether or not the impact of Ukraine on the world economy is played out? If central banks reckon that the oil price will stay in the range of $100-110, they would be justified in concluding that inflation is the bigger threat at the moment. However, if Russia moves to cut supplies drastically, all bets on oil prices are off and growth is seriously threatened.  

JP Morgan Chase has warned that, in an extreme scenario, Russia could slash dramatically oil supplies in response to the oil price cap imposed by the West. Oil prices could then surge to $380 dollar a barrel. At that price, global growth will collapse and inflation will cease to be the priority for central banks.

So great is the uncertainty created by Ukraine that, after the last meet, Mr Powell refrained from providing forward guidance, that is, any indication of exactly what rate hikes to expect in the coming months. Nor is the Fed in a hurry to return to the inflation target of 2 per cent for the US. It seems quite happy to return to the target by end 2023.

If the task for the Fed is so complicated, the challenge for central banks in emerging markets, including the RBI, can well be imagined. In addition to factoring in the outlook for growth and inflation, they have to keep a wary eye on the exchange rate. Coping with the “spillovers” of Fed policy is testing the mettle of emerging market central banks.

That should explain the stance taken by the Monetary Policy Committee (MPC) of RBI earlier this month. The MPC made no change to its forecasts for growth and inflation in 2022-23. Nevertheless, it thought fit to increase the policy rate by 50 basis points. The MPC argued that the increase was needed to anchor inflation expectations and to bring the inflation rate closer to the target of 4 per cent.  

That does not sound very convincing. With the actions taken so far, the RBI can at best hope to bring the inflation rate down to the target only by end 2023, exactly as the Fed intends to. The RBI, like the Fed, has chosen not to provide forward guidance.

The more plausible explanation is that the RBI is keen to manage the exchange rate of the rupee after the Fed’s rate hike of 75 basis points. The real effective exchange rate of the rupee against a basket of currencies has been steady over the past year. Analysts have argued that we could do with a depreciation in the real effective exchange rate in order to boost exports.

However, when it comes to managing capital flows, it is the exchange rate with respect to the dollar that matters. The dollar is the safe haven for funds. In order to stem the outflow of capital, it is important that the rupee not depreciate too much with respect to the dollar. If portfolio investors sense a steep depreciation with respect to the dollar, they will flee the rupee. The RBI’s policy rate moves are thus substantially dictated by the Fed’s own.  One wonders whether the RBI would have thought it necessary to raise the repo rate if the Fed itself had settled for a more modest increase.

On a broader note, critics of central banks say that central banks failed to catch the impetus to inflation post the pandemic. Many believe central banks have laid the ground for stagflation similar to the one witnessed post the oil shocks of 1973 and 1979. As the annual economic report of the Bank for International Settlements (June 2022) makes clear, the critics are off the mark.  The behaviour of commodity prices this time has been different from that in the 1970s. So are the economic backdrop and monetary policy regimes.

First, the oil price shock has been less severe this time around. Oil price have increased by 50 per cent since mid-2021 and are around their long-term averages. In 1973, oil prices doubled in a month and touched historic highs. Secondly, higher energy prices impact growth to a less extent today because of the reduced energy-intensity of GDP. Thirdly, the 1973 rise in prices happened on the back of several years of rising inflation. In contrast, today’s episode follows years of low inflation. Lastly, the institutional frameworks for monetary policy and for anchoring inflation expectations are far more robust today.

Forecasts of economic doom in the year ahead are premature and central bank-bashing is misplaced. Central banks are not behind the curve on inflation nor is a soft landing inconceivable  in the US. To be sure, things could change dramatically if the conflict in Ukraine worsens. But that is hardly something central banks can prepare for.

(ttrammohan28@gmail.com)

 

 

Inflation in India: potential breach of MPC mandate

There is much breast-beating over the possible breach of the upper limit for inflation of 6 per cent set for the MPC. The RBI has come in for flak from some quarters.

The critics make no allowance for the fact that the challenges facing the world economy are unprecedented. To be doctrinaire in one's approach in such a situation is not helpful.

The inflation rate for the current year is projected at 6.7 per cent (without factoring in steps the RBI would take to contain it). The RBI's approach, reflected in the views of its three members on the MPC, is to bring inflation to within the tolerance band without too much of a sacrifice of growth. I cannot see how this approach can be faulted.

The Indian economy's growth rate sank to 3.7 per cent in 2019-20. Thereafter, in 2020-21 it declined by 6.6 per cent.  It recovered to 8.7 per cent in 2021-22. Real GDP in 2021-22 was just 1.5 per cent above the level in the pre-pandemic year of 2019-20. Under the circumstances, it is impossible for the RBI to ignore the growth imperative. 

Some argue that growth is not part of the mandate of the MPC. Well, it is part of the mandate of the RBI. Are the three RBI representatives on the MPC required to be blind to considerations of growth when they sit on the MPC? The MPC works within the framework of RBI just as RBI, while autonomous, works within the framework of government.

To those who say that the MPC mandate is sacrosanct, I would say: it is certainly not part of the mandate to kill the Indian economy!  

For a vigorous defence of the RBI's approach, you may read Michael Patra's address of June 22.

I have commented on the issue in my last column in BS. As the article is behind a pay wall, I reproduce it below.

FINGER ON THE PULSE

T T RAM MOHAN

Negotiating India’s soft landing  

The glass is half-full. Inflation at the moment may be above the upper limit of the inflation targeting framework but there is room for optimism about growth prospects for the Indian economy in 2022-23.

The inflation rate needs to fall. But analysts seem to be having second thoughts about the degree of monetary tightening that needs to happen. That is the cause for optimism about growth.

The CPI inflation rate touched 7.9 per cent in April followed by 7 per cent in May. In June 2022, the MPC raised its inflation forecast for 2022-23 to 6.7 per cent. There was panic amongst market analysts. Some analysts saw the repo rate going up to as much as 6.25 percent in 2022-23 over the starting point of 4 per cent.

There seems to have been a rethink since. RBI Deputy Governor Michael Patra’s well-argued address on June 22 to the PhD Chamber of Commerce and Industry has had a sobering effect on the markets. After the address, the yield on the ten-year government bond fell by 18 basis points. That says something about the credibility of RBI’s pronouncements on monetary policy.

Mr Patra made three important points. First, he indicated that we might expect inflation to fall back into the tolerance band of 2-6 per cent by the fourth quarter of 2022-23. Secondly, Mr Patra seemed hopeful that “monetary policy actions in India will be more moderate than elsewhere in the world”.

The third point is potentially more controversial. Mr Patra indicated that inflation may exceed 6 per cent for three successive quarters, which would be a breach of the MPC’s mandate. However, if India’s GDP can grow at 6-7 per cent in this year and the next, “the RBI will have fulfilled its mandate of prioritising price stability while being mindful of growth.”

Read together, the second and third points could be interpreted to mean that interest rate hikes hereafter would not be so drastic as to cause GDP growth to fall below 6 per cent. This approach may result in a breach in the accountability mandate of the Monetary Policy Committee (MPC). So be it, Mr Patra seemed to suggest.

Some are outraged. How could the MPC countenance such a breach? Mr Patra has a plausible response: these are “extraordinary times”. Nobody can disagree. Having just emerged from successive waves of the pandemic, the world economy is facing new supply constraints. The last thing we need now is that, in reining in demand, we create supply constraints within the Indian economy as well. The critical issue in managing inflation is not so much the precise level of inflation as the predictability of it. The RBI must not give guidance that misleads the market. That is clearly not the case here.

So far, so smooth. The spoiler could be the actions of the US Federal Reserve. The Fed has of late taken a ‘we will do whatever it takes’ approach to fighting inflation. Market analysts feel the Fed could hike interest rates by a further 120-150 basis points in the months ahead. If the RBI were to match that, the repo rate could rise to as much as 6.4 per cent. That would render a soft landing difficult for the Indian economy.

The best outcome would be that the Fed does not hike the policy rate as much as feared. The other possibility is that the RBI does not have to match the Fed’s rate hikes. The price to be paid is a further flight of portfolio funds and a depreciation in the rupee.  We can live with such a depreciation. Despite the fall in the exchange rate of the rupee with respect to the dollar, the 40-currency real effective exchange of the rupee has remained virtually unchanged in May 2022 compared to May 2021.

Mr Patra is right. When it comes to a soft landing, India is better placed than the US and many European economies. Even at May’s inflation rate of 7 per cent, inflation in India is 2.5 percentage points above the average for the previous five years. In the US, the difference is about 5.5 percentage points. Monetary tightening required is greater in the US.

Secondly, as the latest annual report of the Bank of International Settlements notes, the Phillips curve, which gives the trade-off between inflation and unemployment, has turned flat in the US in recent years. The flatter the Phillips curve, the greater is the monetary tightening required to produce a given fall in the inflation rate. In India, the Phillips curve seems to have acquired its normal shape after having been relatively flat for six years starting 2014. (RBI Bulletin, November 2021).

Mr Patra’s address, which echoed many points the RBI Governor had made earlier, may prove to have been a turning point in shaping the inflation trajectory in the months ahead.

Banking sector in good shape

The health of the banking sector is yet another cause for optimism about the economic outlook. The latest Financial Stability Report of RBI points to several indicators of improvement.

Gross Non-Performing Assets (GNPAs) were at a six-year low of 5.9 per cent of advances in March 2022. They are expected to fall further to 5.2 per cent in March 2023. Capital adequacy in the banking system averages 16.7 per cent, a full 5.2 percentages points above the regulatory minimum.  Provision coverage ratio is at a healthy 71 per cent. Annual credit growth in June 2022 was 13.1 per cent, a rate last recorded in March 2019. India’s banking system can be said to have emerged from a banking crisis that lasted nearly a decade.

If the projected NPA level is correct, regulatory forbearance during Covid has paid off. It hasn’t ended up postponing the day of reckoning, as critics had feared.  

Unless the geopolitical situation worsens considerably, the Indian economy should manage growth of 6.5-7 per cent in 2022-23 while inflation falls gradually to within the tolerance band. In today’s troubled environment, that would be a considerable achievement. It would show that the Indian economy is stronger today than in earlier crises and we are getting better at macro-economic management.

Central bank independence: Response to a reader's comment

In response to my post on central bank independence, a reader comments:

Aren't you using the pandemic-induced exceptional circumstance to rubbish Acharya's thesis? Granted that exceptional situations require a less doctrinaire approach but that apart i think there is merit in the view that a restructured standard asset is an oxymoron. I am one with you on accountability though. Take the issue of bank supervision. Musn't the RBI be held accountable for sleeping at the wheel and waking up too late to the crisis, the more so given its nominees were on the Boards of PSU banks? There cannot be independence without accountability.  

First, my basic problem is with Viral Acharya's thesis that fiscal dominance is the root cause of our banking woes. If that were so, how does one explain recurrent banking crises in economies where there has been no fiscal dominance? 

Adair Turner, former Chairman of UK's Financial Services Authority, explains in his book, Between Debt and the Devil, that money creation happens either by government or through the banking system. He argues that both can be equally irresponsible in the creation of money. The financial crisis was the result, not of fiat money created by government, but excess loan creation by private bankers. So, the idea that if government practises fiscal prudence, banking crises will somehow disappear seems rather misplaced.

Secondly, about loan restructuring or 'kicking the can down the road'. At the risk of sounding heretical, I make bold to say that without some kicking of the can down the road, it's impossible to practise banking. The question is one of proportion. If, say, 5 per cent of loans are restructured, it is not an issue; if the proportion of 25 per cent, there is certainly an issue. Next, restructuring must be based on sound financial considerations, it should not happen for mala fide reasons. Subject to these to two caveats, one should not have an issue with loan restructuring. 

Especially in the case of infrastructure projects and SMEs, where cash flows can be uncertain for reasons beyond the control of firm management, one cannot rigidly apply NPA norms and despatch the firm to IBC. Bankers need to exercise their judgement in handling such cases. That they refuse to in today's fraught environment is a different matter.

Thirdly, about the accountability of RBI. Not all of the bad loan problem is the result of irresponsible lending. The Economic Survey of 2016 argued persuasively that much of the NPA problem was the result of factors extraneous to management: 

Without doubt, there are cases where debt repayment problems have been caused by diversion of funds. But the vast bulk of the problem has been caused by unexpected changes in the economic environment: timetables, exchange rates, and growth rate assumptions going wrong.

   

So the idea that there was a colossal management failure at PSBs to which the RBI nominees were party is suspect, to say the least.

 

Where the RBI, perhaps, went wrong was in its over-zealous approach to NPA recognition under the Asset Quality Review. In one year, 2016, the ratio of gross NPAs to advances jumped to 7.48 per cent from 4.27 per cent in 2015. This led to a severe capital crunch, which affected credit growth, which affected borrowers and led on to more NPAs.

 

One could argue that it was not lack of central bank independence but the assertion of independence through an extremely stringent AQR that led on to major problems for the banking sector and the economy at large. The issue was not so much lack of supervision as the RBI's response to the NPA issue when it surfaced. This also was the reason for the tensions that emerged between the RBI and the government. 

Inflation targeting in India: RBI's mandate must be modified

Barry Eichengreen, the well known economist, thinks inflation targeting is working in India and that it's good to stick to it. His views come at a time when the regime is seen to be coming in the way of cranking up growth just when the economy is suffering a huge contraction.

Eichengreen cites a co-authored paper of his which shows that the inflation targeting regime is "functioning well" in India. The RBI uses both price stability and growth to determine its policy rate. Policy has not become more hawkish after the regime was put in place. It has made for better anchoring of inflation expectations. Even when the inflation rate moves up, inflation expectations don't go up because people believe the RBI is capable of reining it in. In other words, the credibility of RBI has gone up consequent to inflation targeting.

Eichengreen, however, sees room for improvement especially in RBI's management of expectations of inflation. The data shows that while the RBI is able to manage expectations of professionals well, it hasn't done a great job of managing the expectations of ordinary people. He urges the RBI to reach out and better communicate to ordinary people.

All this is fine but the inflation targeting regime may still need modification. The problem thus far has not been with the inflation regime so much as how the RBI has interpreted it until recently. Although the upper limit for inflation in our regime is 6 per cent, the RBI chose to focus on a target of 4 per cent in practice. As the lower limit of 2 per cent is not particularly relevant now, why not make the mandate more specific by asking the RBI to limit inflation to 6 per cent instead of setting a band of 2-6 per cent?

Perhaps this can be done once the current spurt in inflation subsides and inflation falls below 6 per cent. The time to modify the regime is when the going is good, not when the going is bad. If the government moves to modify the inflation target at a time when the fiscal deficit of the centre and the states is poised to be rise to around 12 per cent of gdp and inflation is running above the limit of 6 per cent, it is unlikely to sit well with rating agencies and investors. At least one of the two closely watched indicators must look good before any change is attempted. 

Inflation must be kept under control. But inflation cannot be allowed to control macro-policy.

Raghuram Rajan back in the news

Raghuram Rajan was in India recently and he hold forth on a wide range of subjects in numerous interviews. Many interviewers tried hard to to get him to say that his differences with the government on demonetisation caused his exit from RBI. Rajan didn't quite oblige.

He was also asked if he would have resigned if demonetisation had been pushed in his time as Governor. He said he could have answered the question only if he had been confronted with the proposition when he was Governor. All he could say now was that if a civil servant did not want to go along with any government measure, the only option was resignation.

I thought his views on the banking sector deserved more coverage than those on demonetisation- he didn't really have much to add to the latter.

My column on this subject in BS is reproduced below:

Rajan in the limelight again
 
T T Ram Mohan
 
Former Reserve Bank of India (RBI) governor Raghuram Rajan came, he saw, he conquered the media. For a year following his exit as RBI governor, Dr Rajan had chosen to maintain silence on the Indian economy. During his recent visit to India, it was hard to open a newspaper or switch on a channel without seeing an interview with him.

The interviews covered pretty much the same ground, with the focus always on demonetisation. Dr Rajan said many things that would have gladdened the hearts of those critical of the initiative. Yes, he had expressed his reservations when the proposal was put to him. And, yes, he thought the short-term costs were steep — he mentioned estimates in the range of 1-2 per cent of the gross domestic product (GDP). And, yes again, he wasn’t sure the long-term benefits justified the costs. It’s fair to say that Dr Rajan hasn’t added anything to the debate on the subject. We do not have a handle yet on either the costs or the benefits of demonetisation.

The focus on demonetisation was a bit unfortunate as it overshadowed some pretty strong remarks Dr Rajan made about the banking system. Dr Rajan expressed reservations about mergers of public sector banks (PSBs). He warned that it would be unwise to attempt mergers at a time when PSBs were weak and wrestling with the problem of high levels of non-performing assets. One hopes the finance ministry is listening.

Dr Rajan was equally forthright on the need to do what it takes to recapitalise PSBs. He went so far as to say that the government should provide the necessary capital to PSBs even if it meant cutting allocations on other heads. The government and the top brass at the RBI have been telling us that some PSBs are so hopelessly deficient in managerial capabilities that putting more capital into them is money down the drain. Rajan clearly doesn’t think so.

We have thus far got banks to clean up their balance sheets without providing them the necessary capital. By many estimates, PSBs would require another ~1 lakh crore in order to meet the regulatory capital requirement. The Budget for this year has provided for just ~20,000 crore. Dr Rajan believes this is a sure recipe for holding up growth in credit and private investment.

Dr Rajan’s views on reform of governance at PSBs are rather more debatable. He wants the Banks Board Bureau (BBB) to have greater autonomy from the government. He would like the Department of Financial Services (DFS), whose job is to monitor PSBs, to be closed down. He wants PSBs to be monitored entirely by independent boards, presumably appointed by a truly independent BBB.

These views have wide currency today. However, the notion that PSBs should be freed from the supposed tyranny of the DFS is conceptually flawed. It overlooks a crucial fact about the governance model that obtains in India: Ownership of enterprises, whether in the public sector or the private sector, is not widely dispersed, as it is in the Anglo-Saxon model. We have instead a dominant owner in either the government or in industrial houses.

Where there is a dominant owner, the role of the board is rather more limited than in cases where ownership is widely dispersed. It is natural for the dominant owner to call the shots. The government cannot be expected to adopt a hands-off policy towards PSBs any more than Tata, Birla or Ambani can in their enterprises.

Moreover, it is possible to overstate the effectiveness of “independent” boards. Boards the world over are notoriously ineffective, which is why corporate governance is still work in progress more than two decades after the movement began. Those familiar with the working of PSBs would know that it is the government director and the RBI director who often make the most meaningful interventions.

Leaving matters at PSBs entirely to independent directors could, therefore, create a dangerous governance vacuum. There remains a case for the DFS to play a monitoring role. What is undesirable is that the DFS should issue directives to the CEOs of PSBs. Instead, the DFS should communicate its views through its nominee directors on boards, thereby strengthening the effectiveness of boards.

What Dr Rajan did not say is also significant. Dr Rajan is no foe of the private sector. Yet he made no mention of privatising any of the PSBs. Dr Rajan’s silence on privatisation at a time when “strategic sale” is the buzzword should make the finance ministry sit up and take note.

Subbarao and RBI autonomy

D Subbarao's recent book on his tenure as RBI governor has occasioned another bout of government-bashing. Ministers trying to browbeat the RBI, we are told, is nothing new. What happened to Rajan also happened to Subbarao.

I haven't read the book but I have gone through the excerpts and reports that have appeared in the media. I can't resist the feeling that the idea of the RBI's autonomy being threatened by the government is hugely overblown.

When it comes to internal matters of the RBI, there is virtually no interference. On recruitment, pay and perks (broadly within the government framework), promotions, and numerous other matters, the RBI has a free hand.

On matters that impact on the economy- monetary policy, bank regulation, exchange rates, etc- yes, the government does seek to influence outcomes. But seeking to influence is not the same as browbeating or imposing. There are discussions and phone calls and the government conveys its views. There is nothing wrong with that as long as the it's left to the RBI governor to take the final call- and that has been pretty much the case with both Subbarao and Rajan.

What many people mean by autonomy is that the RBI should be left to its own devices in these matters and also that terms of RBI governors should be automatically renewed. That's too much to expect of any government, it won't happen and it isn't even desirable. The government is responsible for overall economic outcomes and thus will influence decisions at RBI and will also want to have as governor or deputy governor individuals with whom it has a degree of comfort. This does not, in my view, conflict with central bank independence.

More in my article in the Hindu, Limits to autonomy