The history of monetary policy in India, and of the Reserve Bank of India (RBI), has seen twists and turns that date back to pre-independence India. The RBI itself was created on April 1, 1935 and has since managed a sometimes difficult, sometimes cordial relationship with the government of the day. It has faced innumerable challenges – some tackled with excellence, others not.
“The RBI has many problems to deal with but none as annoying as its date of birth – All Fools' Day, 1935. Ever since then, it has wriggled with embarrassment whenever a jubilee – silver, gold and platinum – comes along. But on all other counts it has little to be ashamed of, not the least of which is the fact that it was the first central bank to be set up in the non-white world,” writes TCA Srinivasa Raghavan in his book ‘Dialogue Of The Deaf'.
Raghavan, a journalist for more than 35 years, has also consulted with the RBI to help put together Volume 3 and Volume 4 of the central bank's history. Dialogue Of The Deaf traces the history of the politics of monetary policy in India and details the relationship between the country's government, its central bank and its central bank governors.
A few excerpts from the book follow.
Independence Of Monetary Policy
In India, the independence of monetary policy has been confused with the independence of the governors who have perhaps never heard of Montagu Norman's view of the RBI as a wife in a Hindu joint family who advises but does what she is told.
He believed that the relationship between the RBI and the Bank of England should be that of a ‘Hindoo marriage' wherein the former was the dominant spouse and the latter the subservient wife.
The problems started almost as soon as the RBI came into being. The first governor simply didn't get the point that he had to do as bidden. It is widely believed today that it was the Nehru-TTK-Rau episode of 1958 that set the tone for the government-RBI relationship. That was when the RBI Governor, Sir Benegal Rama Rau was told just what the RBI's place was in the scheme of things. TTK had yelled at him and Rau had protested to Nehru, who told him if he didn't like it, he could leave.
In fact, however, the nature of the relationship had been determined twenty-one years earlier when the finance member, Sir John Grigg, had ‘persuaded' Sir Osborne to leave over the question of who the real boss was. Grigg had a simple formula for judging a governor's attitude: where he stood on ‘ration and protection'. Sir Osborne didn't endear himself to the British by calling the Viceroy ‘weak ass'. That entire episode is shrouded in mystery, leading the late SS Tarapore, one of the great central bankers India has produced, to demand that, ‘The RBI owes it to posterity to release a dedicated volume on the Osborne Smith episode – warts and all'. In his place was appointed Sir John Taylor who was a loyalist.
As far as independence goes the best summation has come from a recent Governor, Dr YV Reddy: ‘We are totally free – within the limits set by the government.'
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Reserve Bank In The 1990s
The RBI played a crucial role in the 1990s. There was a fundamental change in the relationship between the government and the RBI. From 1991 onwards, it became a full, if slightly junior, partner of the Finance Ministry instead of being what in north India is called a jhamoora or a sidekick.
Three successive finance ministers treated the RBI as a professional body instead of, as TTK had called it, a ‘subordinate office of the government'. It didn't become independent in the way the term is sometimes defined by western economists so that political considerations ceased to be its concern. But it did become the primus inter pares amongst regulators of whom many were to follow to supervise the many new markets that were beginning to slowly take root.
Between 1991 and 2004, when the United Progressive Alliance (UPA) I came to power with the peculiar demands it made on the exchequer because of Sonia Gandhi and her National Advisory Council, not to mention the prickly and egotistic personality of the Finance Minister P Chidambaram, the RBI was as independent as any legislation for independence was going to make it.
But from about mid-2005 onwards, the relationship slowly began to deteriorate.
There were two major factors that contributed to the healthier relationship: the finance ministers and the key officials of the finance ministry who, as economists, had a better understanding of the RBI's role in the economy. The ministers were happy to let it take the blame, much as under the UPA the government was happy to let the Supreme Court do the politically unpopular work.
But in the 1990s, it was different.
Singh who became finance minister in July 1991 had been RBI governor between 1982 and 1985 and had worked closely with C. Rangarajan as his deputy governor. They were both economists and had very similar views about the direction the economy needed to take. Later when Singh became prime minister he would appoint Rangarajan as the head of his economic advisory council. Other than Montek Singh Ahluwalia, he was the only person Singh trusted fully.
The relationship between Singh and Rangarajan's predecessor, Venkitaramanan was less cordial but they worked in perfect unison for the eighteen months between July 1991 and December 1992 when Venkitaramanan demitted office. The officials, on their part, needed the RBI's technical expertise in an increasingly complex economy as it began to integrate with the world economy.
The Finance Ministry, whose economists came from the Indian Economic Service –barring a few honorable exceptions – were simply not up to the task. Indeed, it wouldn't be far off the mark to say that the technical skills of the even the top economist officials of the Finance Ministry had rusted. They were primarily bureaucrats with a superior understanding of economics than mere IAS bureaucrats who learnt on the job and flew by the seat of their pants. Their World Bank and IMF training told them the destination and which direction to take; but they didn't know how to get there. For that they needed the RBI.
Staying Relevant
The new worry for central banks is – or should be – what are called bitcoins. These are digital money invented by a mysterious Japanese genius called Satoshi Nakamoto, whose real identity is yet to be verified. According to Wikipedia, bitcoins are issued ‘as a reward for payment processing work in which users offer their computing power to verify and record payments into a public ledger…bitcoins can be exchanged for other currencies, products, and services. Users can send and receive bitcoins for an optional transaction fee.'
The key feature of bitcoins is that they don't need an intermediary like a central bank. Everything is between the principals, or as they are known, peer-to-peer transactions. Every currency has an exchange rate and those with money – cash or bank account –can obtain the equivalent number of bitcoins.
The question now is: how soon will these replace traditional currency and should that happen, what will central banks do?
That eventuality, however, might be some time away in the future. More imminently, central banks have to worry about more traditional things like the size of their balance sheet which is a superior euphemism for how much their governments owe them.
The more the debt, the bigger is the balance sheet of a central bank. Between 2008 and 2015, central banks lent prodigiously to their governments. This level of debt is no longer sustainable and they are gradually starting to lend less. The result is the global economic contraction which we are witnessing today. It is anyone's guess how long it will continue and if it will lead to conditions similar to 1929-39. It took a large number of local and global wars to sort that out.
Then there is the question of maintaining public trust: how far can we believe the notion that central banks always know what they are doing and how vulnerable are they to political/sovereign bullying? As mentioned above, the period 2008-2012 was one where the Indian government mercilessly bullied the RBI. This has been known to happen elsewhere. In other countries, the central banks have stood firm but are beginning to yield ground. In yet other places, there is tacit collusion with the governments.
All in all, therefore, the credibility of central banks is coming under strain and they will have to work very hard to convince the public that they are almost omniscient.
Excerpted with permission from Dialogue of the Deaf: The Government and the RBI by TCA Srinivasa Raghavan, Tranquebar, March 2017.
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