Heading Towards Authoritarianism
Big Government and Poor Governance
In India, the Reserve Bank of
India, being the central bank, creates
liabilities in the form of cash notes held by the rest of the economy as assets. The RBI regulates the functioning of a large part of the financial sector, particularly the commercial banks, and controls the supply of money. It discharges two of its most important functions, namely stabilizing the price level and influencing the cost of borrowing through what is known as monetary policy. In its functioning, it obviously affects macroeconomic variables like the price level, aggregate investment, growth of GDP, foreign exchange rates and the inflow and outflow of international capital. The functioning of the RBI is not accountable to the polity, and it constitutes an area where economic policy is delinked from the political process. It is important that any central bank retains this independence.
Over the past two or three years, the RBI has, however been under pressure to reduce interest rates even when inflation rates were reasonably high. On behalf of the RBI, it was argued that controlling inflation was more important than rate cuts given the existing state of health of the economy. The finance ministry's position was that in view of the importance of the management of fiscal deficit, there was no scope of expansion of government expenditure, often an alternative way of stimulating demand and growth. The RBI had held on its independence and in reaction, the government made changes whereby a committee would take the decision and in a group of six, three would be appointed by the finance ministry and the RBI governor would have the casting vote in case the need arose. With a new governor at the helm of affairs the change produced an immediate effect; a rate cut was announced. Then came the shock of demonetization of five hundred and one thousand rupee notes. It is intriguing that the announcement of demonetization although its impact on the supply of money was to be huge, came not from the RBI, but from the Prime Minister, thus undermining the independence of the RBI. From the press meet following the decision, where a senior civil servant, who was not an RBI official, did the bulk of talking, it appeared that the RBI officials were not very sure of what the economic implications of the decisions would be. When the Prime Minister announced the decision of demonetization of two types of currency notes, he mentioned three objectives—unearthing black money, stopping fake notes from being printed, and snapping the links between the first two kinds of notes and terrorism. Since there are specialized institutions and policy mechanisms that are supposed to implement these, it was a failure of governance if these institutions and mechanisms had been unsuccessful in the past. Overnight, the RBI and the commercial banks became crime-control agencies made to work on the assumption that every citizen unless proved innocent, was guilty. Matters are worsened by the fact that the benchmark of innocence kept changing every few days even coming down for a day to the level of having Rs 5000 in old currency notes. The RBI has been made a virtual department of the government by virtue of complete subservience to the government and the continuous but random changes in the procedures of replacing old notes, and in this department, the RBI senior officials were to behave like mid-level minions in the civil service whose vocabulary seemed to have become limited to exactly three words: Yes Prime Minister. This effect of erosion of the independence of the RBI on the economy will be long-term; especially how the rest of the world perceives policy-making in India. Confidence in the financial sector and its regulation has taken a serious beating. From the economic literature on public policy-making has emerged a conventional wisdom that claims clear superiority of the policies based on known rules of transparency over discretionary policies. People are today witnessing discretionary randomness at its worst touted as responsive governance.
The sanctity of the monetary liabilities created by the RBI has another technical aspect. The liabilities of the RBI would go down to the extent that older notes do not come back to the banking system. Adjustments of the asset side of the balance sheet would have to be made giving rise to the speculation that these " extra" assets could be utilized to recapitalize banks or given to the government for budgetary use. The RBI governor, in one of his statements, claimed that he would not make any alteration in the balance sheet after the swapping time-window closed. Currency notes not coming back to the baking system would continue to be the liability of the RBI. Understandably, here the RBI would have to stick to the promise of made on the note "I promise to pay the bearer the sum of....". Yet the notes are no longer legal tender. This means that one cannot settle debts with such notes, but the RBI retains its promise to give one the sum or Rs 500 or Rs.1000 as the case may be.
There has been a shift in the narrative of demonetization, with more propaganda on ushering in a cashless economy with electronic payments only. But India is still far away from coming even close to a developed market economy in terms of IT infrastructure. If the government tries to force the issue, it would create the double impact of undermining confidence and creating major disruptions in production and demand. Nobody knows what the next sift in the Prime Minister's narrative might be, but it is evident that the RBI is playing second fiddle to the government and in doing so, has actually hurt the economy by its policies for the first time in its illustrious career.
There are talks that the Prime Minister may have long term political objectives in mind which he has hinted at more than once. Pains are therefore considered an essential part of this transition to the long term. The importance of the central bank and the role it is supposed to play are understood by very few Indians, and most have not even heard of the RBI. Hence any political gamble can be played safely and signal may be given that all disruptions are for the greatest common benefit for the greatest number. The Prime Minister might be correct in his gamble. The poor may not be affected much. After all how much more can one hurt a person living below the poverty line? But even if many have not heard of the RBI or understand its important functions, the fact will remain that one more important institution capitulated to the pressures of the government and gave away its independence. It is, contrary to the electoral promise of the Prime Minister, about reinforcing big government and poor governance. Above all, it is the signal of the arrival of big governance and even bigger whimsy conducted by one individual with a large and growing fan following.
Vol. 49, No.27, Jan 8 - 14, 2017