Viral Acharya On Central Bank Independence, Inflation And Fiscal Risks

“Why do old men wake so early? Is it to have one longer day?” wonders Santiago, the old fisherman, in “Old Man and the Sea” by Ernest Hemingway. I found myself preparing and writing these minutes early too, perhaps so I could have one longer drafting day!”

Days before Viral Acharya went public with his decision to step down as deputy governor of the Reserve Bank of India, he began his statement as part of the minutes of the June Monetary Policy Committee meet with musings from an Ernest Hemingway classic. Unknown at the time, Acharya had already resigned as deputy governor and, perhaps, saw the statement as one last opportunity to flag off key issues facing the economy while still on the inside.

He spoke of the fiscal risks building up in India and upside risks to inflation that India must not ignore even though price pressures are currently under control. He spoke with conviction and detailed the risks as he saw them, even though most of these concerns did not find their way into the final resolution of the June MPC meet.

In many ways, Acharya’s last statement, was characteristic of his tenure — one in which he has taken a principled stance on issues ranging from the central bank’s balancesheet to banking regulation and inflation to fiscal risks.

Acharya is set to exit the central bank at the end of July, the central bank confirmed in a statement on Monday.

Fighting For The Cause Of Central Bank Independence

Acharya’s strongest speech was on the issue of central bank independence. It was October 2018 and the RBI was in the middle of a battle with the Government over a host of issues, including how much capital the central bank should hold.

Acharya used a lecture in Mumbai to bring out the perils of the path taken by the government, backed by then Governor Urjit Patel.

He went on to cite the example of Argentina where the central bank governor was forced to resign in protest of the Argentinian government’s decision to take reserves off the central bank’s balancesheet. The markets eventually punished the country for it.

While not drawing a direct comparison, Acharya suggested that the government’s intention to access the RBI’s capital reserves to meet its expenses could lead to significant market volatility.

A decision on the question of how much capital the RBI should hold on its balancesheet remains unanswered as Acharya exits. A committee set up to review the matter is still to submit its recommendations, amidst reports of a continued dispute between the government representative on the committee and other members.

Talking Tough To Financial Markets

Acharya’s tough talking approach was not limited to sending messages to the government. He was equally blunt in speaking to the markets.

In a speech in January 2018, Acharya told a gathering of money market professionals that the central bank will not manage interest rate risk for them.

“Despite the existence of the facility to short sell and availability of futures and swap markets, it appears that for most banks investment activity essentially consists of two steps – buying and hoping for the best. But hope should not be a Treasury desk’s primary trading strategy,” Acharya said while addressing the Fixed Income Money Markets And Derivatives Association (FIMMDA).

Asking the regulator to help banks in times of distress is “akin to the use of steroids” Acharya said. “They get addictive and have long-term adverse effects in the form of frequent relapse even though their use may be justified to relieve occasional intense pain,” he added.

More recently, Acharya has resisted calls from the market for easier liquidity and a bail-out window for non-bank lenders. While the RBI is reviewing its liquidity framework, Acharya’s position has been that the inter-bank call money rate is a good benchmark to determine the liquidity needs of the economy.

In response to calls for support for struggling non-bank lenders, Acharya, in December, made it clear that the RBI does not feel the need to intervene even though it stands ready to be the ‘Lender of Last Resort.’

Standing Guard Against Inflation, Fiscal Risks

Acharya last tough message was on emerging fiscal risks and the need to keep a keen eye on any build-up of inflation.

India’s monetary policy committee has cut rates three times since the start of 2019, with Acharya voting against the cut in February and April. He voted for a rate cut in June, albeit with “some hesitation”, he said while adding that he sees this as “insurance” against a further slowdown.

While noting the widening output gap, Acharya came across as the quintessential central banker and kept his focus on inflation risks. One such risk, he said, could emerge from government finances.

Acharya noted that overall public sector borrowing requirements– which appropriately accounts for extra-budgetary resources and other off-balance sheet borrowings of central and state governments –have now reached between 8-9 percent of GDP.

Acharya highlighted there is a significant aggregate demand push linked to government expenditure that needs to be recognised as a source of inflation. He added that increase in issuance of public debt and country risk premium can feed into imported inflation.

In addition, high public sector borrowing can impair monetary policy transmission due to crowding out effects on bonds and bank deposits through small savings which continue to offer rates that are significantly higher than market yields, Acharya cautioned.

His concerns, however, went unaddressed in the final resolution of the MPC, which made no mention of the build-up of fiscal risks.

Back To Academics

Acharya will move out of his Mint Street corner office at the end of July, as he returns to academics to teach a course in economics at New York University in the fall. Perhaps, just like Raghuram Rajan, who Acharya was often compared to, he too will continue highlighting concerns that India should be mindful of. This time from the outside.