An RBI caught in the midst of a govt trying to boost its political fortunes through populism will emerge as a damaged institution.
The RBI-government saga continues to grab the headlines, even as broader political events unfold. Indeed, the state assembly elections and the looming national election represent the backdrop and driver of much of what has transpired in the world of Mint Road and North Block. Last month, it seemed that the conflict between the government and the RBI would boil over, with some suggesting that then RBI Governor Urjit Patel was about to resign. The November 19 RBI board meeting appeared to have calmed the waters, but that was clearly not the case. On December 10, Patel resigned, seemingly taking the government by surprise. But the government recovered quickly, appointing one of its own, Shaktikanta Das, a senior IAS officer. In some respects, this is a throwback to the norm of earlier days, when senior bureaucrats with a range of administrative experience were given the helm of the RBI. Das certainly fits this familiar mould, having served as revenue secretary as well as economic affairs secretary, and with an impressive résumé in economic policy experience, though that includes the controversial demonetisation policy of 2016. What should we make of this situation? Has the government scored an own goal, or is the final outcome a brilliant save?
One view is that Patel’s resignation is an extremely negative signal that will damage future economic prospects. An opposite perspective is that RBI is a strong and resilient institution, and no single individual matters. The truth is complex, and somewhere in between these two poles of opinion. Certainly, individuals do matter. In the US, Fed chairman Ben Bernanke made an enormous positive difference at the time of the financial crisis, whereas his predecessor, Alan Greenspan, probably contributed to the development of that crisis. It remains to be seen how the new RBI governor will do. Recent examples of bureaucrats becoming RBI governors, such as YV Reddy and D Subbarao, may provide some grounds for cautious optimism.
On the other hand, one can argue that the current circumstances are different. Patel’s resignation may well be an indicator of political pressures that, if not checked, will lead to undermining the reputation of RBI as an inflation fighter and, more generally, economic manager. Indeed, Patel, and Raghuram Rajan before him, inherited a problem of non-performing assets in banks that has been the main trigger of the conflict between the government and RBI. That problem developed under the watch of Subbarao, which suggests that individuals do matter.
The earlier failure to monitor banks adequately also suggests that RBI has been far from perfect as an institution. In this regard, the government’s approach in triggering a conflict with RBI and precipitating Patel’s resignation could not have been worse. There may be a case for a temporary easing up of the process of cleaning up the banking sector, because of threats from recent events such as the collapse of IL&FS. Indeed, Ben Bernanke undertook extraordinary and unprecedented policy steps in the face of the financial crisis a decade ago. But the government’s heavy-handedness has diverted attention from legitimate concerns about financial stability, replacing them with what appears as a power grab driven by political motives.
Indeed, I would argue that demonetisation was another government initiative that appeared to sacrifice economic stability and progress for short term political gains. Given the increased importance of foreign capital for India’s growth needs, as compared to the recent past, anything that undermines global confidence in India’s economic policy making institutions is undesirable. Even the quick appointment of a new RBI governor, in that case, leaves the impression of having scored an own goal, and the best one can expect is an uphill task of getting an equalizer. Now, attempts to improve short term liquidity and financial stability which might have seemed technically correct under Patel, may appear to be politically driven under his successor. The same applies to attempts to improve RBI’s workings or optimally reallocate its responsibilities. Even good policies may come under suspicion.
Perceptions matter. But so does reality. The real danger is that, with the results of the assembly elections making the ruling party more insecure about the general election next year, it will embark on a more reckless course of action, trying to pump up the economy or resorting to economic populism, or pursuing its agenda of cultural nationalism more vigorously. None of these will lead to good longer run outcomes. An RBI that is caught up in this trajectory will be a damaged institution.
No one is arguing that RBI or its leadership have been perfect. In recent columns, I have tried to pinpoint where it could have done better, and could do better with certain reforms. But institutional reform requires trust and cooperation, not undermining what has already been built up. To use a different metaphor than the sporting one, the government has taken more than one step backward in the complex task of developing and strengthening India’s financial sector, including its regulation. A long road has been made longer.