Former Reserve Bank of India (RBI) governor YV Reddy, in his book Advice and Dissent--My Life in Public Service, recalls an instance when he wanted to resign over differences with the then Union finance minister, P Chidambaram and how he changed his mind after many in the government including the then Prime Minister Manmohan Singh persuaded him not to do so. Perhaps, the current governor, Urjit Patel may not have that luxury should he face a similar situation.
As I write this piece, television channels are busy speculating that the Union government has initiated consultations with the RBI to initiate section 7 of the RBI Act and if this is indeed invoked, the RBI governor may step down to mark his protest. The section basically enables the government to issue direct orders to the central bank and has never been invoked so far in India’s history. In other words, the RBI Act doesn’t give the central bank absolute autonomy.
This is what the Act says. “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.”
The context of this speculation is the serious differences between the RBI and the Narendra Modi government over multiple issues including RBI’s management of the liquidity situation post Infrastructure Leasing and Financial Services (IL&FS) crisis, the way bad loan clean-up process is carried out and prompt corrective action (PCA) is implemented for a nearly dozen state-run banks, interest rate policy and the central bank’s dissent on a proposed move to take away the status of payments regulator.
Section 7 a recipe for chaos
If the government invokes this section and it leads to the resignation of the governor, it can almost immediately trigger a crisis in the financial system at this point when there is a crisis of confidence in the system on account of nosediving rupee, the non banking financial company (NBFC) default scare that has led to a liquidity squeeze in the financial system and the threat of global interest rates going up with US economy picking up steam and crude oil prices heading further north. It would tell the world that India has undermined the central bank’s importance in official terms.
As this writer pointed out in a column yesterday, it is the duty of a government in a well-functioning democracy to ensure that the central bank is operating with functional autonomy. The simple reason being it is the central bank and not the government that is the guardian of the economy from the perspective of a foreign investor. If the message that goes abroad from the ongoing turf war is that the government is undermining the autonomy of the central bank, it can prove to be detrimental to the economy.
A sense of uncertainty in the central bank’s independence in dispensing its job can take the confidence away from the investor community, which is not what India wants at this point when the rupee is on a free fall and in the backdrop of a troubled global economy.
Urjit Patel’s tenure
Patel’s actions can be criticised for his passive role during the controversial demonetisation execution and the way the bad loan clean-up has been executed with aggression or even the way he and his colleagues at the MPC (monetary policy committee) have approached the interest rate policy. But, overall Patel has done a commendable job in sticking to the mandate of the RBI during difficult times despite heavy criticism and in an environment when political pressure becomes the predominant force in influencing the course of the economy.
New RBI governors often see something big, really big happening in the immediate days after they take over charge. For D Subbarao, it was the global financial crisis. Within days after he took over are governor, Lehman Brothers filed for bankruptcy and all hell broke loose across financial markets. For Raghuram Rajan, it was the US Fed shocks and a freefalling rupee and for Patel, it was the demonetisation challenge thrown by the Narendra Modi government.
Patel drew a lot of flak for the slow counting of old notes. When he appeared before a Parliamentary panel to explain the delay, Patel was ridiculed and criticised. He became the subject of social media jokes. But, it didn’t make sense to bay for Patel’s blood. He was an extra in the PM Modi show on demonetisation. In hindsight, this was also part of Modi government's plan to gradually deconstruct the image of the central bank post the 'rockstar' Raghuram Rajan-era.
But, if one excludes the demonetisation episode, Patel has played a crucial role in the RBI. It won't be an exaggeration to say that Patel is the architect of India's new retail price-focused inflation-targeting monetary policy infrastructure. It was a panel headed by Patel which gave shape to the CPI-inflation based policy and the formation of Monetary Policy Committee (MPC) structure. Monetary policy, which used to be a one-man show of the RBI governor till then became a team show, with the governor being only one member of the panel. The MPCs unrelenting focus on inflation target and its conservative stance on rate hikes/cuts worked well to bring inflation under control, although the fight is far from over even now.
Patel has never been a darling of the media unlike his predecessor Raghuram Rajan, but more like a technocrat who kept his head down and worked hard. That was exactly what the Modi government wanted too and didn’t find that in the outspoken Rajan. Over the years, Patel has proved that he is his own man when it comes to taking calls on critical policy functions.
In 2017, Patel and his colleagues at the MPC had the courage to say no to the finance ministry when it sought a meeting prior to the monetary policy. Patel also made a public pitch for more powers for the central bank in the regulation of state-run banks. The government retorted saying there are already enough powers with RBI to regulate PSBs and the debate is still on.
It is fair to say that the shy, conservative Patel has done a commendable job in guiding the central bank through difficult times and, of all his assignments has carried forwarded the politically sensitive task of cleaning up the loan books of government-owned banks with much courage and conviction. Minus the demonetisation episode, Patel hasn’t buckled under pressure and that’s exactly what a central bank governor should do in difficult times in an economy.
To sum up, it is important to send out a message to the outside world that India deeply guards the sanctity of its central bank, which is the guardian of the economy. If a message goes out to foreign investors and rating agencies that India is undermining the importance of its central bank as RBI deputy governor Viral Acharya said in a recent speech, that will inflict catastrophic effects on the financial system, the larger economy and will dent India’s image internationally. India certainly can’t afford that. The government shouldn’t invoke the controversial Section 7 of the RBI Act and trigger a chaos. Hold on Urjit Patel.
Updated Date: Oct 31, 2018 11:33 AM