The price of dissent

Resignation is the price of dissent in India today, especially for those occupying high government offices. The days when differences over policy matters on growth, inflation and financial stability were resolved in private – within the four walls of the North Block or the Reserve bank of India (RBI) headquarters in Mint Street, are over. When relations were governed more by mutual trust and a healthy respect, and there was a conscious attempt on both sides to present a united front, not just before domestic and foreign players but also for the public. Spats between the government and the RBI had rarely turned so ugly, so public and relations so acrimonious that a central bank governor was forced to resign. That is, until now. RBI governor Urjit Patel resigned citing personal reasons on Monday.

Things have gone from bad to worse in the past couple of years, as the economy started to slow, the adverse impact of demonetisation, the poorly implemented goods and service tax, and high crude prices, started to bite.  Public statements against each other, debates and arguments on Twitter and selective leakages through the media became the norm rather than an exception. While the government wanted growth and employment at all costs, the central bank was all for tempering growth with financial stability, especially in a pre-election year.

The government also started intruding in the RBI’s policy-making turf and asking it, among other things, to open up a liquidity window for the small, medium and micro industries, adversely impacted by demonetisation, and non-banking financial institutions, (NBFCs) hard-hit by cash crunch as a fallout of the IL&FS fiasco. The issue of infusing sector-specific liquidity have been a bone of contention between the RBI and the government with the central bank refusing to toe the government line, forcefully arguing that there is ample liquidity in the system.

The government's call to return the “excessive reserves” lying in the RBI coffer, for more productive purposes too has fallen on the deaf ears of the central bank. The RBI has repeatedly said that it requires the reserves to conduct its monetary policy objectives like protecting the rupee from extreme volatility, managing foreign exchange reserves and being the lender of last resort.

It has also stated that allowing state-run weak banks or those under the “prompt corrective action” framework, to lend would hurt the RBI's move to repair their balance sheets, and add to the non-performing assets of the banks.

The government also packed the RBI board with people with a certain political affiliation, pushing the board to become far more aggressive and even threatening to use Section 7 of the RBI Act of 1934 – which allows the government to dictate policy issues to the central bank.

Even the November 19 RBI meeting, when expectations were that some sanity will return between the two warring factions, it was not really so. It did nothing to reduce the simmering tensions but only fanned it.  It now seems that the two had pulled back from the brink only to fight for another day with more vigour.

Eventually, fed up with orders and constant barrage of criticism from the North Block, the governor decided to end his innings, just days before the next RBI meeting on December 14, to save himself from further humiliation and to protect the autonomy and independence of the central bank.

While there have been many such differences of opinion between the government and the RBI, one will have to go to the days of the first Prime Minister, Jawaharlal Nehru to find an example of an RBI governor resigning from office . The then RBI governor Sir Benegal Rama Rau, had to quit in January 1957, when the Prime Minister sided with his finance minister T T Krishnamachari, after the governor complained about the finance minister’s rude behaviour over differences that began with a budget proposal. The differences between the two offices have continued to this day, with former RBI governor Raghuram Rajan being the first governor not to get a full five-year term, despite the RBI Act of 1934 allowing it.

But trying to force the central banks to toe its line has always been on the government agenda in democratic nations. U.S. presidents too have had constant run-ins with the central bank’s chief to hold down rates. Most famously, White House tapes have shown how President Richard Nixon had arm-twisted Arthur Burns, the then Fed chief to keep policy rates low, push-up growth and employment and boost his chances of re-election. However, it resulted in stagflation—raging inflation and joblessness and Burns’ successor Paul Volcker had to continuously raise rates during the 1980s to tame stagflation. Even Jerome Powell, the current U.S. Fed chief, has been publicly criticised by the President, Donald Trump.

Protecting the RBI’s autonomy in these times is especially critical because it governs and regulates across a vast financial and monetary space—where wrong actions taken to accommodate some needs of the government can have a systemic and far-reaching negative effects on the economy. Moreover, since the objectives and the time cycle of a central bank and the government are different, it is best that the two be kept apart and allowed to function on their own.

The signals had been flashing for sometimes now and it was only a matter of time before someone had to give in, and it had to be the RBI. In fact, Viral Acharya, deputy governor of the RBI, had recently warned that governments that do not respect the central bank’s independence, "will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution". It immediately drew a sarcastic remark from Subhash Chandra Garg, secretary, department of economic affairs: “Rupee trading at less than 73 to a dollar; Brent crude below $73 a barrel; markets up by over four per cent during the week and bond yields below 7.8 per cent. Wrath of the markets," he tweeted.

Similarly N. S Viswanathan, deputy governor, RBI, in his October 29 speech at the XLRI management institute in Jamshedpur, defended the regulator’s strict capitalisation norms and adherence to internationally-accepted Basel guidelines for banks. “A strong and stable banking system, he argued is essential for the development of the economy. The real strength will come from recognising weaknesses in the balance sheet and making provisions for them rather than pretending to believe that the balance sheet is strong,’’  he had said. Not to mention, that the RBI is ensuring that future governments also should not accuse it “of looking the other way when banks were giving loans indiscriminately.’’

In fact, Patel innings had started on a wrong note. Even before he could settle down in his new job, the whole RBI board was taken to Kolkata to sign on the dotted line; to give legitimacy to demonetisation. From then on he had to face the wrath not only of the common public, but also of the Supreme Court, the Standing Committee of Parliament and the Central Information Commission either for not disclosing the amount that came back to the system after demonetisation or for not making public the names of the top defaulters. In all these cases, he had to take the blame for no fault of his own or his team. His constant run-ins with the government on issues or regulating public sector banks and liquidity infusion into the system, among others had probably convinced him that he would not get an extension.

So what does the resignation of the RBI governor mean for foreign and domestic players and the public at large? For the public, it is a signal that the government has scant respect for other important institutions, or for a system of checks and balances so important for the smooth running of a democracy. For both domestic and foreign investors, it would be a time of anxiety, of a wait-and-watch policy not knowing where decision-making is headed. Both domestic and foreign investors look for cues from statements of the RBI governor and the finance minister before taking any investment decisions. Now that will be put on hold. Moreover, without any check on the government, there is always the fear of inflation going up, with its consequent impact on the rupee and the economy because of the government’s propensity to spend in an election year.

In fact, a study by global investment bank Goldman Sachs has shown that government spending usually spikes before the upcoming state and national elections in India. “In a year preceding an election, on average the central and state governments spend an additional 0.5 % to 0.9% of GDP respectively, compared to non-election years,’’ says the report.

For the government, it is hugely important that it appoints a governor at the earliest, before the crucial December 14 RBI board meet. But whosoever takes on the mantle of the RBI governor, will have the difficult task of convincing that he is really independent and that he will work to uphold the autonomy and independence of the central bank. Compromising the independence of the RBI at this critical juncture when the economy is buffeted by a slowing economy, trade wars, agricultural distress is not a good omen in the long-run for a democracy like India.