Saturday 14 January 2017

The rupee stops at Urjit Patel’s door (Sunday Guardian)

By M D Nalapat

There is a possibility that the demonetisation announced on 8 November had been discussed threadbare within the RBI much before that date.

On January 20, Reserve Bank Governor Urjit Patel and others are expected to testify before the Public Accounts Committee (PAC) of Parliament on the 8 November 2016 announcement extinguishing at four hours’ notice, 86% of India’s currency. Because government agencies are—seven decades of “independence” later—still faithful to the colonial practice of not trusting natives with information, all that is available to go by are newspaper reports. These claim that the RBI has written to the committee that it had been “advised on 7 November by the government to recommend the (demonetisation) measure, which it promptly did”. The impression conveyed through this missive is that the RBI has been railroaded into backing the 8 November measure by an omnipotent government. Hopefully, such an impression is incorrect. Else, it will be recorded that the Reserve Bank of India has become a not very significant department of the government, rather than the autonomous institution the Central bank of any major market economy is presumed to be. The lightning response of the RBI and its Board of Directors to the “advice” proffered by the “government” is explainable only in the context of two competing hypotheses. The first is that the RBI Board has become a mere rubber stamp, jumping to attention and approving any policy urged on it by the government. It is clear from the speed of the RBI’s response to the advice it got a day earlier that only a rudimentary examination of the matter would have been carried out at that point in time by the Central bank, which has more than a few excellent economists within its portals. The fact that the recommended policy got approved in such a short time, despite its complex and hugely consequential nature indicates, according to this view, that the RBI has transferred its core responsibilities to the government.
However, there is a second possibility, which is that the demonetisation announced by Prime Minister Narendra Modi on 8 November had, in fact, been discussed threadbare within the RBI much before 8 November, so that the Governor and the Board of Directors therefore went through only a pro forma examination and approval of the scheme on 7 November, in view of their having been in favour of the measure well before it was announced. Were RBI Governor Patel to have had any doubts about the 8 November measure, he would have expressed them earlier to the government. Surely the Governor and the Board of Directors of the RBI are not a collection of individuals helpless in the face of any “advice” coming from the government of the day. If the Governor and his colleagues disagreed with the demonetisation decision, and if his views were ignored, surely Patel would have sent in his resignation. However, from the start the RBI Governor has shown no signs of recalcitrance, standing fully behind the policy. Given that monetary policy is, in practice, the responsibility of the Central bank, the widespread perception that he and his institution were railroaded into going along with a measure that they may have had doubts about is doing substantial damage to the global reputation of the RBI. Should the view take hold that the present RBI Governor is but a postman, carrying communications back and forth, but without any actual input in the policy process, Urjit Patel would earn the reputation of being the least impressive Governor in the history of the Reserve Bank of India. Hopefully, on 20 January, Governor Patel will clear his name by confirming that the 8 November policy had been exhaustively researched by him before being approved. That the RBI was, from the start, at the core of planning a policy that was boldly announced by the Prime Minister despite the huge political risk to him. After all, by tradition and longstanding practice, the rupee stops at the door of the RBI Governor and not that of the Prime Minister, which is why the signature on the new currency notes is that of Patel, rather than Modi.
It would be apparent even to those extravagantly praising the 8 November measure that the manner of its implementation—if allowed to continue — may significantly damage confidence in not just the rupee, but the banking system as a whole, specifically the RBI. Pushing through the measure without ensuring liquidity at the level needed for economic expansion was an act of monetary risk-taking on a record-breaking scale. Hence, the importance that the Reserve Bank of India as well as the Finance Ministry officials testify in public as to why they believe such a step was essential, including in its timing and phasing. The multiple amendments to the orders given to the banks, almost all of which went contrary to the promise of the RBI Governor that each rupee note would be honoured in full on presentation, have made the RBI a focus of comments across the globe, few of which is complimentary. The PAC hearings present an opportunity for the RBI Governor and Finance Ministry policymakers to demonstrate that India is not a banana republic, where momentous policies get decided overnight and without adequate study, and whose Central bank lacks any authority or indeed a role in the framing of monetary policy. Governor Patel needs to redeem the RBI’s name by stepping forward and taking responsibility for a measure that he must have been very much in favour of, doubtless for good economic reasons that he needs to elucidate publicly. Patel should also clarify that his backing for the move was no split second decision, but was carefully considered and cleared much before 8 November 2016.

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