Cockroach in the Cherry bowl

My detailed analysis of the budget for Pragati is available here. I am reproducing only the last two pages of it here, that analyses the relationship between the present Government of India and the Reserve Bank of India. I am quite disappointed with what is happening. I was rather surprised and fully agreed with what Siddharth Singh wrote in MINT on the same topic. You can read his piece here.

My comments on the ‘Government – RBI relationship’:

The announcement on the setting up of an autonomous Bank Board Bureau for public sector banks as an interim measure to not only select bank heads but also help them in recapitalisation shows that the government is serious about operationalising the pledge of non-interference made by the Prime Minister to banks recently. Details, especially the timelines, are missing.

The absence of a plan for dealing with the existing stock of non-performing and restructured loans with banks is also a disappointing and serious omission. Reduction of the bad debt stock in banks and their recapitalisation are critical for the flow of credit to the new infrastructure fund and various government corporations as outlined in the budget speech and as envisaged in the expenditure proposals of the Ministries of Roads and Railways, in particular.

Above all, the most regressive measure outlined in the budget speech is the proposed appropriation of the powers of the central bank on the management of capital flows. Capital flows management is a technocratic matter. It is best left to experts and not left to bureaucrats who have no special expertise in capital flow management or to politicians. The Central Government frames policies on foreign direct investment in any case. There was absolutely no need to take on board – partially or fully – the ill-considered and wholly irrational division of responsibility with respect to capital flows on debt and equity and between inflows and outflows, proposed by the Financial Sector Legislative Reforms Commission (FSLRC) which submitted its recommendations to the Government of India in 2013. The Finance Minister should consider retreating from this ill-considered proposal.

In fact, subsequent to the budget presentation, it has come to light [11] that the Government intends to transfer powers on the regulation of derivatives that derive their value from underlying ‘securities’ with ‘securities’ as defined [12] in Section 45U (e) of the Reserve Bank of India Act 1934 as amended in 2009. In addition, the power to regulate Repurchase (repo) and Reverse Repurchase (Reverse Repo) transactions on government securities are being removed from RBI.

Simply put, the power to regulate derivatives on all government (Central, State and local) debt and repo and reverse repo transactions on government debt shall, henceforth, vest with SEBI and not with RBI. The transfer of regulatory powers with respect to derivatives whose values are derived from underlying government debt securities may be understandable because the government has plans to set up a separate PDMA to issue and manage public debt, which task is currently performed by RBI.

However, to vest regulation of transactions in Repo and Reverse Repo securities with SEBI is baffling, to say the least. Repo and Reverse Repo transactions are usually undertaken in government securities and are used by banks to manage their liquidity. The counterparty in such transactions undertaken by commercial banks is the central bank of the country. To entrust the regulation of these transactions to the regulator of Securities Markets makes no sense, to put it mildly. That it was not mentioned in the Budget speech raises more disturbing questions about the motives and goals of the exercise.

This leaves us with one disturbing conclusion: the government has not applied its mind to the FSLRC recommendations. In many respects, the recommendations of the FSLRC appear to have been framed with the sole purpose of undermining RBI. It is hard to present evidence on intentions but such an inference is reasonably drawn through an examination of the various recommendations of FSLRC. If all recommendations of FSLRC are implemented, RBI will only be responsible for monetary policy, which will be decided by a Monetary Policy Committee (MPC) dominated by government nominees. Responsibility for regulation of banking and payments will be given to a separate regulator. Financial Stability will be in the hands of the Financial Stability and Development Council, which will be overseen by the Finance Minister. In other words, the Reserve Bank of India will be reduced to the role of a relatively unimportant department of the Ministry of Finance while the Governor’s job will be that of a rubber stamp of the MPC overwhelmingly staffed with government nominees.

It is important to understand the context in which this is happening. The United States is keen to open up services sectors in developing countries for its corporations. Its bilateral investment treaties are means to that end. The transfer of regulatory powers over the financial system and the financial sector from RBI, with its stellar reputation for integrity and distance from the financial sector, to the government raises the risk of regulatory and other forms of capture of the government by the financial industry.

The United States may be either unwilling or unable to reverse financialisation. However, world over, it is being recognised that financialisation has wrought havoc with economic system stability and has contributed, at least partially, to rising wealth and income inequality. It has spawned excessive executive compensation policies that have harmed long-term interests of shareholder, workers and the economy. Such policies have incentivised corporate managements to accord primacy to the goal of boosting share prices in the short-term over investing surpluses for long-term growth. Serious rethinking is going on in several capitals on reining in and even reversing financialisation of economies.

In India, RBI has won praise from well-meaning and disinterested observers and academics for its calibrated and cautious approach to financial liberalisation. If the government and the Finance Minister, in particular, were open-minded about educating themselves on the complexities of regulating the modern and globalised financial sector, it could do no worse than starting by reading three pieces links to which are given in the footnote below.[13]

The government should consult widely with past RBI Governors and study international practices and experience in this matter. The government’s treatment of national institutions should transcend both short-term and personality based considerations.

In fact, just as the Food Security and the Land Acquisition (Rehabilitation and Resettlement) Bills are the worst legacies of the previous government that have caused semi-permanent damage to India’s future growth potential, this government’s legacy might become the evisceration of one of India’s reputed institutions, trusted for competence and integrity. That it reflects no learning from recent experiences in the world with financial liberalisation is madness. That the process could be unfolding, unintended and unconsciously, is sadness.

The Union Government budget for 2015-16 has several things going for it. It has taken calculated risks with the purpose of boosting the country’s productive potential. Hence, one did not want to end this piece on a note of disappointment. But, it is a fact that one cockroach is enough to spoil a bowl of cherries.

The references cited above as footnote (13):

[13] ‘The Monetary Policy Lab’MINT, September 2007.
The Reddy years at RBI’MINT, September 2008.
How India avoided a crisis’New York Times, December 2008
What the US Fed needs to learn from RBI’MINT, September 2014


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