Shooting itself in the foot

The government's repeated attempts to undermine the hard-won de-facto autonomy of the Reserve Bank of India bodes ill not only for the central bank but also for the country.

The appointment of a deputy governor (DG) in the Reserve Bank of India (RBI) is usually a humdrum, routine affair. An extension in the term of a serving deputy governor is even more so.

Consequently, when the term of Shyamala Gopinath, one of the two deputy governors appointed from within the RBI was extended in September 2009, it got no more than a brief mention in the business dailies.
    
Understandably! It is not unusual for deputy governors to get reappointed — former governor Y V Reddy’s term as DG was extended, as was Jagdish Capoor’s, Vepa Kamesam’s and Rakesh Mohan’s to mention just a few of the more recent instances. So Gopinath’s reappointment was seen as par for the course, a fairly routine development that merited no more than a brief mention.
    
In contrast, almost all business papers played up a report of the government setting up a search committee to identify a successor to Usha Thorat, the other DG from the ranks of the RBI. Why?
    
For one it marked a break from the past. According to well-established precedent of the four RBI deputy governors, one is normally from the Indian Administrative Service (IAS); another, a commercial banker, the third an economist and the fourth, a central banker. When the governor himself/herself (though we are yet to see a woman governor!) was from the IAS, the RBI got an additional post.
    
The idea was to have the right mix of experience and knowledge of central banking, commercial banking and economics at the top with the governor, usually an experienced bureaucrat from the finance ministry, completing the team. So in the present scenario where governor is from the IAS, the fourth DG should, going by time-tested precedent, be appointed from within the central bank when Thorat’s term ends in November.
    
In which case where is the need for the government to set up a search committee? Logically the governor should be the best judge of the quality and competence of the DGs/executive directors working under him? After all if the governor is expected to deliver on his mandate he should be allowed the freedom to choose his team.
    
However, that is not the only reason the report made news. The fact is unlike in September 2009 when Gopinath was given a fresh term, matters have increasingly come to a head between the finance ministry and the RBI. Reporters, with their nose for news, know a news story when they see one! They know, instinctively, what qualifies as ‘news’. And in the instant case they are dot on.
    
The decision not to give Thorat an extension is part of the ongoing struggle between the finance ministry and the RBI; an attempt to bring to heel a spunky regulator that does not hesitate to speak its mind (even if it is in the teeth of opposition from the finance ministry).
    
Whether on capital account convertibility or sovereign borrowing (both of which have investment banks salivating at the prospect of commissions and fees, never mind that it is not in the long-term interests of the country), the bank has successfully resisted pressure from vested interests. The fact that the crisis ultimately proved it right and left the ministry with egg on its face should have humbled the latter. Instead it seems to have riled it.
    
Consequently, over the past few months, the ministry has taken every opportunity to clip the bank’s wings. Starting with the decision to set up an FSDC (Financial Stability and Development Council), to setting up a working group on foreign investment without a single member from the RBI, to the ordinance, now enacted as The Securities and Insurance Laws (Amendment and Validation) Act 2010, that downgrades the RBI governor from his earlier position as first among equals to officially playing second fiddle to the finance minister and most recently, to the decision to appoint a search committee to find a successor to Thorat, one of its most competent officers, the ministry has steadily chipped away at RBI’s powers.

Thorat was, perhaps, seen as a thorn in the flesh for her principled stand on a host of issues, most notably nailing the Tayals of Bank of Rajasthan.
    
The most glaring attack on the bank’s autonomy, of course, is the decision to set up an FSDC under the chairmanship of the finance minister. At a time when most countries are giving more powers to their central banks — the UK government went so far as to scrap the Financial Services Authority — the government’s decision to reverse gear is incomprehensible.
    
‘I know of no other parliamentary democracy with separation of powers among decision-making authorities on fiscal and monetary issues where there is a formal committee like the FSDC with the finance minister as chairman and the central bank governor as vice-chairman,’ says Bimal Jalan.

He should know, having worked as RBI governor and as finance secretary to the government of India. He adds, ‘the potential danger of setting up a committee of this type is that it confers powers on the government to formally intervene in financial regulatory issues, including monetary policy.’
    
Why is this dangerous? Because governments, particularly elected governments have a short-term perspective. Governments don’t think beyond the next election. Strong central banks are necessary to protect us from the worst excesses of government.

Today when central banks all over the world are busy buying government debt, central bank independence might seem a bit of a myth and the government’s latest attempts to cut the ground from under its feet a matter of trifling detail. But it is not! It is only the thin edge of the wedge; another attempt to chip away at the hard-won operational autonomy the bank has gained over the years.
    
As Adam Posen, an external member of the Bank of England monetary policy committee put it, what matters for (central bank) independence is (the) ability to say ‘no’ (to political pressure) and mean it, while still holding the right to buy bonds when the economy needs it.
    
With the government snipping away at the RBI’s de-facto (though not de-jure independence) the fear is that the RBI will lose its ability to say no. That will be a sad day for both the RBI and for India. Strong institutions are the only guardians of democracy, especially in a fledgling democracy.