Mint street blues

“Most people accept the Federal Reserve - the manager of the nation's money stock - as an indispensable institution that the US cannot function without and so they do not question it. But I assure you, especially in this post meltdown world, that it is irresponsible, ineffective and ultimately useless to have a serious economic debate without considering fundamental issues about money and its quality, as well the Fed's massive role in manipulating money to our economic ruin”. Ron Paul in ' End the Fed'. Those are extreme views but Ron Paul a former congressman is not alone. Even Thomas Jefferson and Abraham Lincoln did not trust the Banking system and the latter considered the banking system as his most formidable enemy. This is just to illustrate the different perceptions that prevail about the Federal Reserve of the USA from which country most of our Indian born Economists are drawn to either run our RBI or to advise our government on economic policies, men who probably never saw a village in their lives or ever read the Indian Constitution. This is a good time to introspect on a needless controversy that has erupted in the country between its respected Central Bank and the government, at an easily avoidable time of elections providing political ammunition to the contesting parties. This feat has been achieved only by the so-called professional economists, which more informed and responsible administrators would have avoided.

The concept of central bank autonomy has evolved over the years to enable a regulatory institution to take decisions to control inflation and maintain monetary and exchange rate stability without the exigencies of political requirements influencing the same. Mervyn King who was the Governor of the BOE during the crisis writing in the Financial Times in 2017 about the announcement in 1997 of giving autonomy to the BOE by the then Chancellor of the Exchequer Gordon Brown raised three questions about the autonomy of the BOE. ' What did independence really change? How has the BOE independence affected the performance of the economy and what problems did independence not solve'. He did not answer the third question in the article but stated that independence meant the entrustment of interest rate policy to monetary policy committee and not to the Governor and that had served well the country.

The RBI Act of 1934 more or less gives autonomy to the RBI in the management of monetary policy and exchange rate stability and the Banking Regulation Act 1949 amended recently gives it the power of supervision and control over the banking system. Before the MPC came into existence in India in 2016 it was customary for the Governor to have discussions with the Finance Minister and senior officials before the RBI policy was announced to ensure that there were no contradictions in the fiscal and monetary policies. Undoubtedly on many occasions these discussions had given room for disagreements, whether there was an IAS officer as the Governor or some other professional. These conflicts are bound to arise in a democratic system and they are more often in the Ministries that are under the Ministers but administered by Secretaries as per the transaction of business rules. Secretaries have offered to quit rather than do something against their conscience. By and large they got ironed out and to the credit of ministers generally they did not transgress boundaries when confronted seriously by the Secretary and when they did they got into trouble.

The RBI Act 1934 amended from time to time gives the Governor under section 7 clause 3 of the Act to exercise all the powers conferred on the Bank. In other words, the Governor has been given powers to discharge the responsibilities of the Reserve Bank in regard to the conduct of monetary and exchange rate policies in a manner to maintain stability of the system. The Board too has been given general powers of superintendence over the bank. For purpose of clarity it is essential to quote the section 7. On the management of the Bank
(1) 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.
(2) Subject to any such directions, the general superintendence and direction Of the affairs and business of the Bank shall be entrusted to a Central Board Of Directors which may exercise all powers and do all acts and things which May be exercised or done by the Bank.
(3) Save as otherwise provided in regulations made by the Central Board, the Governor and in his absence the Deputy Governor nominated by him in this behalf, shall also have powers of general superintendence and direction 0f the affairs and the business of the Bank, and may exercise all powers and do all acts and things, which may be exercised or done by the Bank.” It is abundantly clear that the Board that is required to meet only six times in a year would be in no position to exercise the powers of general superintendence and hence clause 3 gives the powers to the Governor and Dy.Governors who are full time employees. Now there is also the Monetary Policy Committee that assists the Bank in the formulation of the monetary policy. The framers of this Act undoubtedly had in mind that both the board and the Governor will function harmoniously in the interest of the country and neither would try to dominate the other as both had equal powers. Under the circumstances no Governor should think that the Board is a mere cardboard but should take its views seriously the assumption being that the members would be chosen for their merit and knowledge required for the purpose. Such a position prevails in all corporate bodies and the board of directors never try to run the company.

Unfortunately, academician economists who get directly inducted to the higher echelons of the Bank tend to assume more importance than are due as they are continuously brought up in theories and models of monetary policy that extol central bank autonomy in their formulation. Their predictive value have rarely been of use or else why would the USA which has the maximum number of Nobel laureates in economics suffer every five to seven years recession and serious financial crises of the like of 2007/2008 that engulfed the world. The purist economists also tend to dismiss realities in the field, the pain and suffering of unemployment and collapse of thousands of small and medium industries consequent on tightening of credit in the name of inflation control. They also think that they can do no wrong. The author experienced first hand when a massive case of foreign exchange fraud misusing the system of LOC running up to several hundred crores perpetrated on several banks in the country came to his notice when he was Revenue Secretary more particularly in the branch of a bank that had been inspected and cleared by the RBI as clean. His letters to the Governor asking for clarification as to how that could that be in a bank cleared by the RBI did not elicit any response whatsoever perhaps on the presumption the king can do no wrong. The matter was mentioned to the then Finance minister who expressed his anger at such neglect on the part of the RBI. The system got changed after persuasion only when the governor changed. The related cases are still pending after 23 years and that also speaks volumes of the incompetence of the Revenue Department in pursuing raid cases in the court.

Those who become Governors from the IAS were usually persons with a decade or more experience in successfully handling state and national finance and invariably with advanced degrees in economics. Both Reddy and Rao had a decade or more of experience and had advanced degrees in economics. Compulsions of the job responsibilities require that they keep abreast of all development in theoretical economics to apply them in policy formulation as required and may be useful in solving problems with their experience of implementing economic policies of the government.

The needless controversy between the government and the RBI is a direct consequence of economists without any practical experience in administering policies at a high level being inducted to executive positions. The powers they suddenly get, let them think that even in a democratic set up they are answerable to none while the elected government gets clobbered every day for troubles in the economic system. Rajan, when he was governor, is reported to have said in a meeting “I am Rajan I do what I do” which speaks volumes for his deference to a democratic polity. The question whether an IAS economic administrator is better suited to be a governor or an economist is more hypothetical. It depends on the learning, experience and leadership qualities required for the job. It also raises the question as to whether an IAS officer who has handled national finance very ably for decades but not an economist can function as a Governor of the RBI. He or she can provided his competence in handling national financial matters has been established beyond doubt. I would say a foreign trained theoretical economist drawn from the foreign academia with no practical experience could at best be an economic adviser and not fit to lead a regulatory institution that has a leading role to play in the fate of the economy.

Has the RBI performed in the sense of Mervyn King? Yes and no. It did handle the financial crises well, thanks also to the govt for the accommodative fiscal policies. It failed to arrest the deteriorating position of the NPAs of the banking system and did not keep checks on the foreign exchange frauds being committed even though it has full control on exchange management. As far as inflation is concerned it is yet to be established empirically that it is the interest rate policy of the RBI that checked inflation and not the decline in oil prices and a general improvement on the supply side of the economy. The truth is still not out as to who initiated the demo move that has caused misery to many and whether the RBI was taken into confidence as it did impinge on their sphere of monetary control.

The lesson to be learnt by the government is that when they select the head of a regulatory body it should not merely be on the basis of academic excellence but also that the person is capable of leading the regulatory body through the vicissitudes in governments and idiosyncrasies of the constitutional institutions of a democratic country. A little known fact is that the DGCA enjoys immense powers under the Aircraft Act and his orders on safety cannot be overruled by the government and so is the case with other regulatory bodies.

A government should never allow tensions to develop between a regulatory institution and itself as it will lead people to question the intentions of the government and the integrity of the institution on which millions repose their faith for justice and welfare. It speaks poorly of both the government and the RBI that they allowed their relations  to become a matter of public debate and even ridicule.

(The author, IAS (Retd), is former Union revenue secretary & Ex-ED of IMF)