There are enough historical precedents to prove that the central bank’s autonomy is good for the country’s long-term economy
The recent uproar in the country regarding the finance ministry apparently coercing the RBI in doing things it is unwilling to do has spiked to such heights that the RBI deputy governor valiantly warned the government that it might “incur the wrath of the financial markets, ignite economic fire” if it undermined an important regulatory institution’s independence. His dramatic analogy with Argentina has made the media question whether we are truly heading towards an Argentinean crisis here. A couple of days later former RBI governor Raghuram Rajan came out in support of the rebellion, and put it more blatantly, saying that the Argentina analogy was just another way to make them understand what curbing powers of RBI might mean for India.
Our country’s political fate is ruled by the prices of onions till today. Let’s come to a clean and clear calculation. Inflation in the economy leads to an inevitable rise in the interest rates. Too much money for too little goods causes inflation and when it does the central bank, wielding its monetary tools, sucks the excess liquidity from the market and leaves people with lesser cash and lesser want for goods thus curbing inflation. Therefore, a rise in the interest rates narrows businesses and opportunities and is not desirable for a growing economy. Consumers tend to buy lesser homes and cars and the growth stalls. High GDP and a low inflation rate is what India is looking for almost two decades now. A country that clearly doesn’t want to be the next Brazil, still developing at a modest rate, need to invest much more in its supply chain networks so that a growing demand for goods is balanced by growing supply of the same. Now when we have understood the basics of the Indian economic dream we need to look at it from a different perspective.
In Dr Manmohan Singh’s second term, when everything was not as hunky-dory as the first term, when the financial meltdown had affected the economies globally, he tried to resist the blow of the recession with strong measures and as it turned out the excessive public spending and populist schemes that pushed up wages and prices (called ‘wage-price spiral’) with a deliberate attempt to keep the interest rate low leading to an all-time high-double digit inflation and low growth. UPA paid the price.
One needs to understand that Rs 80 for a kg of onion or Rs 90 for a litre of petrol is what determines the politics of this country. Economy does not go that way. A wage-price spiral or a scary stressed asset amounting to Rs 14 lakh crore is not solved overnight. It needs time for a decision to take effect (positive/negative) in the economic arena and for that the policymakers are given an independent institution to work for that is supposed to remain undeterred by elections and political agendas to protect the larger interest of the country.
Now, the recent development that is likely to curb RBI’s autonomy by the government of India is another assertion of the government keeping an eye on the 2019 Lok sabha polls in the upcoming ladder that would do no good in the long run. And this is how we metamorphose retrogressively in terms of relation between an independent institution like RBI and the government, in terms of economic growth. Let’s now look at where RBI’s independence is exactly challenged.
1. (lack of) Control over public sector banks: IMF states RBI’s power over PSBs is materially non-compliant
2. North Block believes that RBI has capital much in excess and wants the surplus
3. RBI is against setting up a payment regulatory board outside its own ambit
To elaborate on these points, the RBI has restrained 11 banks from giving out new loans due to their unrealised huge bad debts, and the government wants it to go easy, so that businesses do not go dry in this season of election. The government wants a larger dividend out of RBI’s profit since it is going to get itself into a lot of populist measures to keep its populist spending promises; whereas RBI wants to reinvest the same and strengthens the institution and the country’s economic foothold.
North Block wants to lower the interest rate. But the central bank has recently increased the same. One must remember that the prime focus of the central bank of almost all the countries is to curb inflation. When Modi came to power, the PMO vested a lot of confidence upon the then RBI governor Rajan in this respect and he, in turn, did his job quite successfully. The interest rate was hiked and inflation was brought down to 3 percent after 2014.
Clearly, the government wants easy money this time and can go to any extent to wring out the bucks, be it invoking Section 7 or by any other way never treaded before.
Now, when we have understood the economic dream that we hanker after as a developing country and the economic reality that we are currently in, let’s now divert our attention to the story of Turkey as a case study and the world where independence of central banks are given much larger importance.
Turkey is not a miracle economy; rather it has been an economic disappointment. Its story illustrates, in the words of economist Ruchir Sharma, “how leaders who don’t understand basic economies, coupled with states that meddle too much and invest too little, can inadvertently nurture inflation”. Both the secular parties and the coalition of Islamist parties were keen to dole out goodies, perks and extravaganzas to win elections. In the early 1990s at one point, a candidate promised every Turkish family “two keys for every household” – one for a house and the other for a car! Investments were made just for the sake of it. No real development or progress was seen. Schemes failed and so did the governments that changed every nine month. With each new government wages were increasing and so were the prices. Turkey’s central bank started printing more and more money, prices were inflated to raise revenue but the mounting debts of the government remained uncovered. Inflation hit 70 percent in 2001. The Turkish Lira lost half of its value overnight. IMF had to intervene when Turkey sought loan and thus came the order for reforms. The central bank was made officially independent, insulating it from political pressure. By 2002’s national election, inflation began to ease and the regime of Islamist leader Recep Tayyip Erdogan began. Reforms went on in this new regime and by 2004 inflation was in single digit, deficit reduced by large numbers, long run of growth ensued with the autonomy of the central bank and steady growth oriented measures.
But as the government grew complacent with its growth of GDP and fall in inflation, Erdogan took a turn for the worse. He started investing in megaprojects with no clear pay-offs to the economy and then again in 2018 the country is facing its worse debt crisis.
Can we say now that Acharya is right in saying that undermining a central bank's independence could be "potentially catastrophic"?
New Zealand was the first country to free the central bank to target inflation. Manufacturers called it undemocratic, unions cried foul and some even wanted Don Brash, the head of the independent central bank, dead. But for Brash, fighting inflation was his number one goal, and he achieved it in only two years, becoming a hero. Canada was next in line to adopt the freedom for its central Bank. Paul Volcker’s victory in reigning inflation as the head of Federal Reserve of America inspired many central bankers. Thus, the victory of a central bank depends largely on the extent of autonomy.
There is clearly a reason why these banks are made independent.
At a time when government deficit is increasing, a cloud of bad debts is looming over the infrastructural development of the country, when growth is getting stalled in the name of fighting corruption and projects stuck in the quagmire of litigation or environmental clearances, the government must not go for accessing easy money looking to reap the immediate electoral benefits. It should act more maturely and in more organised and sensible ways, consulting with the central bank, not arm-twisting it into some hasty decision that the government might have to repent in its second term.
The third generation after independence has not seen their father’s or grandfather’s lifelong savings getting wiped out overnight: The reason behind this is largely the presence of a strong central bank – the absence of which can be calamitous!
The RBI-government meeting on November 19 holds the key of India’s economic and political future, with manifold implications. One must remember it is always the prices of onions that possess the power of toppling any government!
Ghosh is assistant commissioner, Revenue (Group A), West Bengal Revenue Service, Directorate of Commercial Taxes/Ministry of Finance.