Government and the RBI – Part 3

The first best world is that the government follows the letter of the Reserve Bank of India (RBI) Act, as amended. That is, it gives inputs in writing which are taken on record.

​The second best world is that there is a direct communication with the Governor formally, before very meeting and it is taken on record.

The third best world is that the RBI Act is amended – the sections pertaining to the Monetary Policy Committee (MPC) – and the Government formally has a non-voting voice in the MPC meetings.

This is third best because the MPC has just been formally launched and this might strike one as a panic and ad-hoc reaction. Basically, it is too soon to amend it. May be, after two years. That is why this is third best on my list.

The fourth best world is what is happening now : CEA+PEA+DEA Secy. meeting MPC non-RBI and not on record. They are government appointees. The appearance of free-will is important. That might be lost here. Indeed, even if they wish to cut rates on their own, it might not be seen that way but seen as succumbing to government pressure.

Look at the optics for the world of financial markets (fair or unfair is a different issue). This is how they would see it:

A new MPC has four meetings and it has not cut interest rates and has become even neutral to hawkish from being accommodative. The government therefore loses it and wants to interfere. It will have implications for the exchange rate, for funds flows, etc. The narrative about India might change for the worse, from the government point of view.

If the Government has to interact with RBI, it can be Finance Secy. and RBI Governor interacting formally. Perhaps, this was suggested and turned down.

In the final analysis, it boils down to 100 basis points of interest rates. Otherwise, I doubt if the Government would be so exercised about this. I really doubt if a rate cut of any magnitude would be so efficacious as to risk walking down a path a little bit without taking into account long-term consequences. Rate cuts in a balance sheet constrained environment are of little use. Even if the current real policy rate is 3.5%, is it too high for an economy that is supposedly growing at 7+%?

Further, given the experience in India with inflation, it is never easy to let down one’s guard on that. Sonal Varma has a nice piece in MINT today on why it is too soon to declare victory on inflation.

This would set a precedent for future governments to flout protocol and norms even more flagrantly. That is in the nature of the times we live in.

We have a stock market that is rich in valuation. It can go ballistic with 100-200 bp. of rate cuts while doing zilch to capital formation in the real economy. The costs are there for a rate cut of such magnitude.

It is not as though the RBI is missing a sure, riskless bet that would benefit the economy and therefore, the government has to step in.

So, I think that the government might have been better off retreating or doing it much more formally so that the personalities involved matter little.

Government-Central Bank interaction

What do other central banks do?

(1) This is what happens in England:

“A representative from the Treasury also sits with the Committee at its meetings. The Treasury representative can discuss policy issues but is not allowed to vote. The purpose is to ensure that the MPC is fully briefed on fiscal policy developments and other aspects of the Government’s economic policies, and that the Chancellor is kept fully informed about monetary policy.​” [Link]

(2) This is what happens in Japan (from the Bank of Japan Act)

Article 4 The Bank of Japan shall, taking into account the fact that currency and monetary control is a component of overall economic policy, always maintain close contact with the government and exchange views sufficiently, so that its currency and monetary control and the basic stance of the government’s economic policy shall be mutually compatible.

(Attendance of Government Representatives)

Article 19 (1) The Minister of Finance or the Minister of State for Economic and Fiscal Policy prescribed in Article 19, paragraph 2 of the Act for Establishment of the Cabinet Office (Act No. 89 of 1999) (referred to as the “Minister of State for Economic and Fiscal Policy” in the following paragraph; in the case where the office is vacant, it shall be assumed by the Prime Minister) may, when necessary, attend and express opinions at Board meetings for monetary control matters, or may designate an official of the Ministry of Finance or the Cabinet Office, respectively, to attend and express opinions at such meetings.

(2) The Minister of Finance, or a delegate designated by him/her, and the Minister of State for Economic and Fiscal Policy, or a delegate designated by him/her, may, when attending the Board meetings for monetary control matters, submit proposals concerning monetary control matters, or request that the Board postpone a vote on proposals on monetary control matters submitted at the meeting until the next Board meeting for monetary control matters.

(3) When a request has been made to postpone a vote as prescribed in the preceding paragraph, the Board shall decide whether or not to accommodate the request, in accordance with the Board’s practice for voting.

(Publication of Transcripts, etc.)

Article 20 (1) After each Board meeting for monetary control matters, the chairperson shall promptly prepare a document describing an outline of the discussion at the meeting in accordance with the decisions made by the Board, and make public the document following its approval at another Board meeting for monetary control matters.

(2) The chairperson shall prepare a transcript of each Board meeting for monetary control matters in accordance with the decisions made by the Board, and make public the transcript after the expiration of a period of time which is determined by the Board as ​appropriate. [Link] and [Link]

Indian government to talk to the Monetary Policy Committee regularly

I did see an interview given by Arvind Subramanian, Chief Economic Advisor to the Indian government, to ‘Business Standard’ last week on how the government would begin the process of providing structured inputs to the Monetary Policy Committee (MPC) of the Reserve Bank of India. Three officials from the Department of Economic Affairs – the Chief Economic Advisor, the Principal Economic Advisor and the Secretary to the Department – would meet with the Monetary Policy Committee members.

That was an interesting proposal. My eyebrows went up but I did not blog on it because last week was too busy.

What was not clear from that interview was the structure of the meeting. For example, would these officials travel to Mumbai and meet with the MPC as a group? Would they invite them to Delhi? Would they meet them in separate groups? RBI members and external members (government nominated) separately?

MINT has an Edit on it this morning. It provides some information on the above questions:

The Union finance ministry has summoned the members of the monetary policy committee (MPC) to New Delhi to discuss government views on interest rate policy. The meeting will be attended by chief economic adviser Arvind Subramanian, principal economic adviser Sanjeev Sanyal and economic affairs secretary Shaktikanta Das. There will be two sessions: one with RBI representatives in the MPC and then one with the outside members, a curious arrangement.

That does not make for good optics.

The Edit argued against the idea and said that the notion of independence had to be preserved. It went on to make a forthright suggestion in the end:

The “structured” meetings with finance ministry officials is, similarly, an idea that needs to be junked.

Government providing inputs to central banks is always controversial although the central bankers (not in India) doing the bidding of the private sector does not attract as much criticism as the government provision of inputs does. This is not a criticism against MINT or about the state of affairs in India but a comment in passing, to suggest that the so-called independence of the central banks has been more of a textbook concept or a concept for Editorial writers, around the world.

If Government pressure happened in any case, isn’t it better that it happened in the open?

If the meetings that are now proposed were junked, would the pressure not be happening?

Isn’t it a bit like black markets in drugs? Drugs are bad. But, given that they are sold anyway, would you want them be sold in the open or behind railway stations in the sidings?

I think this is better than secret communication and expression of government preferences in the media before monetary policy meetings.

The amendments to the Reserve Bank of India Act for the purpose of the constitution of the MPC provide for the Government to share its views, when deemed necessary, in writing:

(9) The Central Government may, if it considers necessary, convey its views in writing to the Monetary Policy Committee from time to time. (Section 45ZI, RBI Act 1934, p. 90 as amended up to June 27, 2016 uploaded by RBI in November 2016)

So, what I would tell the government?

(1) I would not want it to be junked. But, the legislation had not envisaged a structured input provision process. So, the government is deviating from the legislation. It has to acknowledge that.

(2) The meetings can alternate between Delhi and Mumbai as a routine – one here and one there. That would take away the bad optics of ‘being summoned to the Durbar’ in Delhi.

(3) The meetings should be with the full MPC and not in groups.

(4) The legislation calls for the input to be provided in writing and not orally. Hence, these meetings should be Minuted and shared with the public along with the Minutes of the MPC Meeting.

If I am not mistaken, this is how it is done in Japan. They do not summon MPC members to the Office of the Treasury but Treasury officials attend the MPC meetings and voices the views of the government.

That would aid public discourse as to why Government wants lower (or higher rates?!) and what are the arguments it puts forward for it.

That is good for policy discourse, good for the institutional mechanism and even hugely educative for students of economics.

Indeed, it would bury the constant bickering between MoF and RBI on interest rates and it would set a very healthy precedent on how to manage the political economy of turf battles between different arms of policymaking.

(5) Once this process is instituted, no one else in the government – the Minister of Finance, his Deputies, the Minister for Commerce, FinMin bureaucrats and the DEA officials too – should have any public comments on monetary policy and interest rates, etc. There should be a very strict gag order like the one on the red beacons now. For example, this should not be permitted.

The government has an opportunity to convert this into a model institutional arrangement and thus set a healthy precedent for similar such interactions between various arms of the government.

More than the ban on the red beacon, it would be a substantive achievement for the Prime Minister if he were to issue guidelines to MoF as suggested above.


To be fair to governments around the world and not just in India, if central banks maintain a tight monetary policy, the government can also claim that it is hurting its fiscal goals since the cost of capital is high with a tight monetary policy. It is particularly so in India since the government has a fiscal deficit target to meet.

It is fair game for the government then to offer its inputs to the central bank just as the central bank wants the government to maintain a prudent fiscal policy since a lax fiscal policy can undermine the central bank’s inflation mandate.

So, therefore, shouldn’t the Reserve Bank of India also shut up and not talk in public about the need for fiscal prudence ahead of the budget? Instead, it can opt for a private and formal consultation with the Ministry of Finance.

Stuff that caught my attention – STCMA 28.5.2017

On its maiden run, Tejas Express finds headphones missing, seats dirty and scratches on TV screens. Should we be pessimistic on India because of its governments and politicians or because of the people? I would say the latter.

Shankkar Aiyar laments the lack of a constructive, credible and serious political opposition to the NDA government. The question is did we ever have it, in our polity?

Shankkar Aiyar also rues the missed opportunity of the ‘Smart Cities’ programme. He is right.

One nation – one ghee dosa – one price: Praveen Chakravarty on the extremely bad idea of the government’s price gouging authority provision in the new GST Bill. True that private sector might not pass on savings. But, his example shows how intrusive an authority to check that, can become. One hopes it is a case of bark rather than bite.

I liked this piece by Pradeep Mehta of CUTS International on NITI Aayog’s three-year action plan.

Appears more of an excuse than a legitimate justification to sideline Paul Romer (ht: Amol Agrawal).

Abhijit Banerje’s piece in ‘Indian Express’ could have been worse.

This piece by Yuval Harari on how the world would cope with technological progress that would render them unemployed is either too subtle for me or it is too frivolous. Perhaps, it is a parody on progress? If so, I like it. (ht Ravikumar from Washington, DC).

This MINT Edit spotlights the speed with which we reconcile to mediocrity and second and third best worlds. It deals with the issue of how the proposed Goods & Services Tax (GST) in India on Services is too complicated.

From the man of the mangled metaphors, this article, superficial as it is, is well worth a read because he has done what good journalists are supposed to do – go and verify things for oneself.

Ramesh Ponnuru on the Liberal blind spots. Short but effective.

There are times one should be happy that articles are behind paywalls and cannot be accessed. Saves time and much else.

Ajit Ranade pays tributes to a silent tree lover who passed away too young. Nice to remember and reflect.

The Third anniversary

I had written a detailed review of the three years of the NDA Government for Swarajya. You can see it here.

A friend took exception my remark that the note-ban exercise may have shaved off more than a percentage point of growth in 2016-17. I still cannot believe that it is an unreasonable remark. When more than 80% of the notes in circulation are withdrawn, by value, it would have an impact on economic activity. The question is by how much and not if it would.

The March Monthly Economic Report of the Department of Economic Affairs provides us some numbers:

As per the second advance estimates of national income, released by the Central Statistics Office (CSO) on February 28, 2017, growth rate of Gross Domestic Product (GDP) at constant market prices was 7.1 per cent in 2016-17 as compared to 7.9 per cent in 2015-16.

The growth in Gross Value Added (GVA) at constant (2011-12) basic prices for the year 2016-17 is estimated to be 6.7 per cent, as compared to 7.8 per cent in 2015-16. At the sectoral level, agriculture, industry and services sectors grew at the rate of 4.4 per cent, 5.8 per cent and 7.9 per cent respectively in 2016-17. [Link]

As regards the growth rate of money supply, this is what the March 2017 economic report had to say:

Growth of Money Supply on year on year (YoY) basis as of 31st March, 2017 stood at 7.3 per cent as compared to a growth rate of 10.0 per cent recorded in the corresponding period in the previous year.

As regards the components of money supply, the growth of ‘currency with the public’ registered decline of 20.8 per cent as of 31st March, 2017 against growth of 15.0 per cent registered during the corresponding period a year ago.

The growth rate of time deposits with banks was 10.5 per cent as of 31st March, 2017 as against 8.8 per cent in recorded in the corresponding period a year ago. On the other hand, demand deposits increased by 19.5 per cent as of 31st March, 2017 as against 13.4 per cent during the same period last year.

Clearly, in a country in which almost all of the retail sales was paid for with cash and informal credit markets happened in cash, it is not that far fetched to believe that economic growth will have been adversely affected when the growth rate of currency with the public was -20.8% for the year ending March 2017.

It has always been the case that the note ban exercise would deliver upfront costs and benefits over time. As for benefits, the government has been focused on digital transactions and its tax implications. It has not done much to encourage formalisation of the economy. Not yet. Tax rates and tax administration, costs of formal operations (labour costs and compliance costs) all remain high and formidable. Hence, the disappointment that the government has not done enough for the benefits to start accruing. At least, not yet.

So, I do not have a problem with what I wrote about the ‘note ban’ exercise as part of my third anniversary appraisal of the government.

Moody’s downgrades China

Moody’s downgraded China’s sovereign credit rating from Aa3 to A1 and upgraded its outlook for the rating to ‘stable’ from ‘negative’. That is, it does not expect to downgrade China again anytime soon.

As soon as it happened, many dismissed it. China government does not borrow in foreign currency and hence, a credit rating action by an international agency does not really matter. Well, not so fast. Even Indian sovereign does not borrow in foreign currency. Yet, its credit rating is just above junk bond rating and is often cited in many commentaries on India’s fiscal health. So, let us not be too nonchalant about it, on behalf of China. Certainly, the Chinese government won’t be.

The fact is that this is the first China rating change by Moody’s in nearly thirty years. It does make people sit up and take notice. Second, China has just come off the OBOR conference where it assembled many foreign leaders. It was almost an emperor’s durbar with the little chieftains in attendance. Hence, to have this happen within a week of that jamboree is a bit of an embarrassment that China could have done without.

For China, ‘face’ matters a lot and hence, a foreign credit rating agency from a country that is, in its view, fast losing its pre-eminence is a reminder to China that the world order had not changed yet. That would be quite annoying.

For India, it would be a bit of a Schadenfreude because India had raised questions about the debt burden it would create for the countries involved. Moody’s downgrade vindicates India in a way.

Second, Arvind Subramanian, the Chief Economic Advisor to the Government of India had been fiercely critical of the credit rating agencies for their lopsided credit rating of India and, say, China. He called the chasm between the sovereign credit ratings of both countries indefensible. India was just above junk bond rating and China’s credit rating was Aa3. He might be somewhat mollified or feeling vindicated although he was batting for an upgrade for India and not so much a downgrade for China.

As for China’s economic fundamentals, they had justified more than a one-notch downgrade long time ago. In its Article IV report last year, the International Monetary Fund had pointed out that China’s ‘augmented fiscal deficit’ was slightly above 10% of GDP in 2016 (p.43). Its public debt ratio too is correspondingly much larger and rising. Even then, no one has the faintest idea of how much debt China’s local governments have taken on and how much of it would devolve on Beijing.

Further, China’s banks are swimming in a sea of bad debts to local government funding vehicles, to State-owned enterprises and, further, on their part, have sold these debts as Wealth Management Products to their private clients, looking for a higher yield with no risk. Their official non-performing asset ratio is less than 2%. But, private estimates range from 5% to 25%. Fitchratings, another credit rating agency, puts it at 15%. Therefore, objective fundamentals warranted a lower credit rating for China.

A colleague had a legitimate question as to why this downgrade did not come earlier, when China’s fundamentals were dodgy as in, say, at the beginning of 2016 or in August last year, etc. The answer is simple. It is that the credit rating agencies did not want to pour oil into the fire and turn China’s turbulence into a self-fulfilling rout. It is better to do it when times are quieter.

Second, the scale of the estimates being touted for the ‘One Belt One Road’ initiative might have influenced Moody’s. It is our guess. The number is variously estimated at USD900bn to USD1.0trn. Hence, this downgrade could be a pre-emptive warning.

The downgrade, while being meaningfully negative for those borrowers that rely on the sovereign rating to price their own debt, may also make the Chinese government think a bit harder about the next round of debt-funded reflation once it gets bored or frightened of the current round of de-leveraging that it is supposedly pursuing.

In all, Moody’s downgrade of China’s sovereign debt might not be a surprise but its timing was unexpected, surely. If anything, the surprise is that it took so long for them to act and the question is why only one notch down.

This article in the Wall Street Journal comparing China and Japan is a good read. Moody’s rates both countries alike now.

Stuff that caught my attention (STCMA) – 23 May 2017 edition

MINT Edit on Conventional politicians and why they are useful

Philippine President says China President threatened war if Philippines explored South China Sea for oil

President Trump’s speech at the Arab-Islamic-American summit

Tulsi Gabbard not pleased with Trump speech in Saudi Arabia.  A sample here.

Spanish government debt again above 100% of GDP

Key achievement of ‘Department of Economic Affairs’: Improvement in India’s macroeconomic stability – say it again, please?

Ministry of Finance of the Government of India has discontinued the mid-year economic appraisal and the monthly economic reports too have not been updated since August 2016. Pity.

Anil Padmanabhan on the political significance of the GST Council meeting in Srinagar

Scott Greet in ‘Daily Caller’: The Predictable catastrophe of firing James Comey [Link]. I checked out his tweets last night. Seems worth following.