Rajan vs Patel: What did RBI advise govt on demonetisation? Can the real central bank please stand up and answer?

Prime Minister Narendra Modi demonetised Rs 500 and Rs 1000 notes on the night of 8 November, 2016 to kill black money, check counterfeit notes, push digitalisation and block terror funding. The merits and demerits of the biggest disruptive economic move in India have been discussed for long by Indians and foreigners using the yardstick of politics and economics. The jury is still out on whether note ban was a success or failure, and might remain so for a long time to come since quantifying the outcome of the exercise isn’t an easy task.

But one question that is important to ask is this: What did the Reserve Bank of India (RBI) think of demonetisation prior to the rollout when the government approached it for its opinion? Did the central bank view demonetisation of Rs 500 and Rs 1,000 notes as a good idea for the Indian economy when the Narendra Modi government introduced it or was it a reluctant participant in the whole exercise? Let’s look at some of the comments from the current RBI governor Urjit Patel and his predecessor to understand the thought process in the central bank  prior to the announcement of demonetisation and after it came into force.

On Wednesday, speaking at the prestigious Harvard Kennedy School in Cambridge, former RBI governor Raghuram Rajan said he had made it quite clear to the government that demonetisation was "not a good idea" and that its implementation was "not well-planned". “I didn't ever say that I wasn't consulted (on demonetisation). In fact, I have made it quite clear that we were consulted and we didn't think it was a good idea," said Rajan, who is currently the Katherine Dusak Miller Distinguished Service Professor of Finance at The University of Chicago's Booth School of Business, adding, demonetisation "was not a well-planned, well thought-out, useful exercise and I told the government that when the idea was first mooted."

Rajan was the RBI governor till the first week of September 2016. So his comments can be safely taken as RBI’s official view for that period. It somewhat contradicts with the Modi government version about demonetisation. Top ministers in the Modi government have all along maintained that demonetisation was a well-thought-out, well-planned move done in consultation with the central bank. On 11 November, 2016, three days after the announcement, Union Home Minister Rajnath Singh said that the decision to demonetise high denomination currency notes was a well-planned move and not taken in haste. "Recently a decision to demonetise currency notes in the denomination of Rs 500 and Rs 1,000 has been taken, it surprised people not only in the country but the world over,” Singh said.

Former RBI chief Raghuram Rajan and current Governor of RBI Urjit Patel. PTI

Former RBI chief Raghuram Rajan and current Governor of RBI Urjit Patel. PTI

A similar statement was made by Union Finance Minister, Arun Jaitley on 17 November, 2016. “The whole thing is a very well-planned and executed move," Jaitley told reporters in New Delhi. That makes it pretty clear now that both the RBI and the government were not on the same page as far as the planning is concerned prior to the announcement of demonetisation, even though the government consulted the RBI on the matter. But, this is not surprising since demonetisation was primarily a political decision  from Modi and the RBI had very little role to play in it.

But was there a consensus with the top brass in the central bank about one of the most disruptive political-economic move witnessed by independent India? This is critical to know to understand demonetisation. To find out this, let’s look at what the current RBI governor Urjit Patel said about the idea of demonetisation and the preparedness for its rollout. On 7 December, 2016 (one month after demonetisation), Patel said: “The decision has not been taken in haste but after detailed deliberations. There had to be a high level of secrecy surrounding this decision and the fact is that such a large country was indeed taken by surprise when the decision was announced."

Was it a good decision according to Patel? In his foreword to the 14th Financial Stability Report, Patel said this. “It is expected to significantly transform the domestic economy in due course in terms of greater intermediation, efficiency gains, accountability and transparency through increasing adoption of digital modes of payments, notwithstanding the short-term disruptions in certain segments of the economy and public hardship.”

Thus, one can safely say that Patel has been largely a supporter of Modi’s big economic move unlike Rajan. To sum up, Patel thinks demonetisation was a well-planned, good move that has several benefits “not taken in haste”. But his predecessor, Rajan felt this wasn’t a good economic move and not well-planned. This means there wasn’t a consensus among the RBI's top brass about the idea of note ban and the level of preparedness. Remember, Patel was Rajan’s deputy before he took over as the governor. An email sent to the RBI on Thursday seeking clarity on this matter remained unanswered. So, was the RBI in support of demonetisation when the government consulted it or not? Will the real RBI please stand up and answer?

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Updated Date: Apr 13, 2018 11:36 AM

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