Dealing with RBI

I reproduce below my column in MINT on Tuesday (March 3, 2015). My last blog post is better read in conjunction with this post:

Finance minister Arun Jaitley continues to draw well-deserved accolades from many sources for a pragmatic budget. Within the constraints he faced, he has done a good job of diverting resources towards investment. At the same time, states have received an unprecedentedly large share of the central tax pool. This columnist would like that spirit to permeate to other decisions he has taken.

The finance minister has proposed to amend the Foreign Exchange Management Act to enable the government to make decisions on capital controls with respect to equity flows. He has argued that decisions on capital controls are policy decisions and not regulatory decisions. If so, then even debt flows should now be controlled by the government. In reality, whether or not capital controls are policy decisions, it makes sense to delegate certain decisions to others to escape extraneous pressures that are exerted on the government from within or from abroad. The government could easily plead helplessness and point to the central bank for unpopular capital control decisions. Most decisions that restrict free movement of capital will be unpopular. In any case, central banks around the world do not take these decisions without prior consultation with governments. Hence, the government wresting control of the decision with respect to equity capital flows goes against the spirit of decentralization.

Under bilateral investment treaties that the US has signed with several nations, many countries are forced to keep their capital accounts open or be prepared to be challenged by those, or even by private parties. In this regard, government agencies may be more vulnerable to pressure than technocratic central banks. Second, having agreed to a monetary policy framework with the Reserve Bank of India, the finance minister has promised to constitute a monetary policy committee in the course of the year. It is important that the monetary policy committee be independent, autonomous and consist of members who are not beholden to the government. It cannot be a committee with a majority consisting of government nominees. That would be a setback to institutional autonomy and competence. Such decisions cannot be influenced by short-term considerations and government preferences on interest rates. This may be a pre-emptive or unnecessary note of caution. So be it.

Many comments have begun circulating that the monetary policy committee would rein in the unilateral tendencies of the current RBI governor. Some have taken to referring to him as the anti-inflation ayatollah. It is very easy to blame interest rates and the central bank for the failure of economic growth to revive. It is harder to set right the many wrongs that hold economic growth back in India—the pro-cyclical fiscal consolidation of 2014-15, excessively geared balance sheets of corporations and non-performing debt in banks. Monetary policy has to take into account not only real economic conditions but also conditions in the financial markets—domestic and global. Counterfactual conditions are impossible to construct in the real world. Ex-post judgments are easy. India’s monetary policy stance should be evaluated independent of the personality of the present RBI governor. But that objectivity is becoming harder for many. The governor must share some of the blame for this.

He has taken to expressing his views on many matters that are outside the purview of the central bank, in public. Most of his comments make sense but in the context of the political discourse in India, they assume different meanings. For someone who already has the ears of the government, it is best if well-meaning advice is given in private. There is no room or need for public grandstanding. In fact, the adviser renders his advice useless by tendering them in public. It would be reasonable for the executive to construe them as adversarial in nature. Consequently, most of them—even sensible ones—would be brushed aside as politically motivated if they are delivered only through public forums.

For instance, in a recent speech, the RBI governor correctly warned that India should not make the mistake of going from a licence-permit raj to an appellate raj. But, in light of his various pronouncements on Make in India on foreign direct investment policies, on inheritance taxes, on strong governments and strong personalities and on budget-making competence in the government, this remark too will be ignored as politically motivated. That is unfortunate. National interest is sacrificed as egos clash.

The finance minister told Parliament that the task force on the formation of the Financial Sector Appellate Tribunal is making satisfactory progress. Once formed, it will hear appeals even against banking regulation decisions made by RBI. To the best of this columnist’s knowledge, such a setup does not exist in other countries. Judicial review is always open to aggrieved parties. This will be an additional layer of second-guessing of regulatory decisions by an appellate authority. For a government that is facing the prospect of judicial second-guessing of its decisions and actions in several areas to create one such forum itself is a tragic irony.

In many aspects, this government is thinking ahead and thinking long-term. With respect to RBI, it will be committing a big mistake if it allows present conditions to influence its decisions. Undermining that institution will hurt the country badly.

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2 thoughts on “Dealing with RBI

  1. While the fiscal federalism is welcome the success will depend on the type of feed back the centre gets back from the states particularly those of under developed ones .Otherwise there will be under spending or misspending.Your note of caution re.the composition of monetary committee is timely so as to avoid the undermining the authority of central bank.You are right that on a few occasions the present R.B.I Governor crossed limits which he could have avoided.

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