Delivering a lecture on 'independence of the central bank' at the St. Stephens College here, the outgoing governor said the central bank cannot be free of all constraints as it has to work under a framework set by the government.
In his last public speech before demitting office, Reserve Bank Governor Raghuram Rajan today made a vigorous case for a strong and independent central bank that can say ‘no’ to highest echelons of the government to ensure macroeconomic stability.
The outspoken RBI Governor, who completes his three-year term tomorrow and will return to academia, also pitched for elevating the ranking of central bank chief saying it is “dangerous to have a de facto powerful position with low de jure status.”
“The central bank should be independent and should be able to say ‘no’ to seemingly attractive proposals,” he said delivering a lecture on ‘Independence of the central bank’ at the St. Stephens College here.
But in the same breath he went on to say that the central bank cannot be free of all constraints as it has to work under a framework set by the government.
Recalling his predecessor D Subbarao’s comments on policy differences with the government, Rajan said he “would go a little further” as he believes that “the Reserve Bank cannot just exist, its ability to say ‘no’ has to be protected.”
He said the ranking of the RBI governor, currently at par with Cabinet Secretary, needed to be commensurate with the role.
“There is a reason why central bank governors sit at the table along with the finance ministers in G-20 meetings,” he said.
Rajan, who had steered the biggest overhaul yet by the RBI including a switch to inflation-targeting under a monetary policy committee, said the freedom to take operational decisions is important for the central bank.
“However, there are always government entities that are seeking oversight over various aspects of RBI’s activities. Multiple layers of scrutiny, especially by entities that do not have the technical understanding, will only hamper decision making,” he said.
Rajan, who has been vocal on issues like religious tolerance, said a central bank governor has to warn about the dangers of certain courses of action or certain tendencies in the economy for growth and macroeconomic stability.
“RBI Governor is also a role model for the youth in this country and should therefore not duck the responsibility to urge them to follow the highest standards of citizenship when he or she is invited to speak directly to them,” he said.
On his tenure, he said under him the central bank had undertaken important reforms with regard to payments and banking system, conduct of monetary policy, liquidity management, financial markets, resolution of distress, besides bringing changes within the RBI itself.
“Only time will tell whether they will have lasting impact, but I tried to do the best job I could, without fear or favour,” he said adding, this was his last public speech as the RBI Governor.
“In a poor country like India where so many people live at the margin, the role of the central bank was to ensure that growth did not exceed the country’s potential, adopting prudential policies that reduce the risk, and building sufficient buffers that the country was protected against shocks,” Rajan said.
He said unlike a developed country, where the central bank chief can offer periodic Delphic pronouncements about the course of monetary policy and occasionally remonstrate with Parliament or the government about the course of fiscal policy, in India the RBI Governor has to continuously make the case for the actions the central bank is taking, including the many structural reforms that are underway.
“In this environment, where the central bank has to occasionally stand firm against the highest echelons of central and state governments, recall the words of my predecessor, Dr. Subbarao, when he said “I do hope the Finance Minister will one day say, ‘I am often frustrated by the Reserve Bank, so frustrated that I want to go for a walk, even if I have to walk alone’. But thank God, the Reserve Bank exists,” the outgoing RBI governor said.
On various entities seeking oversight over the central bank’s activities, he said the government-appointed RBI Board, which includes ex-officio government officials as well as government appointees, should continue to play its key oversight role.
“In this regard, all important RBI decisions including budgets, licences, regulation and supervision are now either approved by the Board or one of its sub-committees. Vacancies in the RBI Board, which have remained unfilled for many months now, should be filled quickly so that the full expertise and oversight of the Board can be utilised,” he said.
“It is the central bank governor, unlike other regulators or government secretaries, who has command over significant policy levers and has to occasionally disagree with the most powerful people in the country,” Rajan added.
The RBI governor’s rank in the government hierarchy is not defined but it is generally agreed that decisions will only be explained only to the Prime Minister and the Finance Minister.
There is an informal understanding in India that the RBI governor has the room to make needed decisions.
“In the interests of macroeconomic stability, none of this should be changed, though if these issues are ever revisited, there may be some virtue in explicitly setting the governor’s rank commensurate with the position as the most important technocrat in charge of economic policy in the country,” he said.
Rajan said macroeconomic stability is of paramount importance for India and also, the central bank must have the resources, knowledge and professionalism to act when the situation warrants.
India, he said, needs a strong and independent RBI to ensure macroeconomic stability.
The outgoing governor said when the responsibilities of the RBI are fuzzy, its actions can continuously be questioned.
“Instead, if the constitutional authorities outline a framework for the responsibilities of the RBI, it can take actions consistent with those responsibilities and be held to outcomes,” he said.
He cited the example of recently outlined inflation target.
“The inflation objectives recently set for the RBI by the government are an example of what is needed. Critics can lambaste the RBI if it fails continuously to meet the objectives, but if they want it to lower interest rates even when the RBI barely meets its objectives, they should instead petition the government to change the objectives,” he said.
The RBI chief added that RBI’s role, however, in macroeconomic stability is still “fuzzy.”
“While RBI clearly has responsibility for the safety and soundness of credit institutions and the stability of the external account, there are some areas that are hazier.
“For example, with an inflation focused framework, the RBI’s ability to be accommodative depends on fiscal prudence from the centre and states.
How much should the RBI warn on fiscal profligacy, including the building up of contingent liabilities, and when should such warning be seen as interfering in the legitimate decisions of the elected representatives of the people? This is an area where clarity would be useful,” he said.