Until June 18, 2016, the majority of even the most aware Indians had not heard of Raghuram Rajan or the Reserve Bank of India (RBI) or its governors. Then suddenly all three became topics of heated discussion everywhere because a BJP MP, Subramanian Swamy, asked that Rajan’s term of three years not be extended…

About a fortnight into the controversy, Rajan announced that he was going back to teaching and research. And thus ended that story with a whimper.

The heavens did not fall.

When Montagu Norman was forced to quit

All governors, since the first one, have confused the independence of monetary policy with the independence of their post. They assume that only they can conduct monetary policy and that the government has no say in it. It might be a good idea, therefore – when they sign the register taking over as governor – to remind them of Montagu Norman’s view.

The governor of the Bank of England from 1920 to 1944, Norman was powerful enough to bring down governments. According to him, the RBI had to be like a wife in a Hindu joint family who advises but does exactly as she is told. He also 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.

His advice went unheeded. No sooner had the RBI come into being than the conflict between the governor and the government began. Sir Osborne Smith had been used to having his way as the managing director of the Imperial Bank of India, which in 1956 became the State Bank of India. He refused to do as bidden by Delhi.

Sir John Grigg, who was the equivalent of the present-day finance minister, had a simpler formula for judging a governor’s attitude: where he stood on the exchange rate and the tariff rate. Sir Osborne was implacably opposed to the exchange rate of one shilling four pence as he was convinced it would be deflationary. He also wanted a lower bank rate. The government would not budge on the former and was scornful of the latter.

Sir Osborne could be outspoken when not required. From the very start of his chairmanship of the Imperial Bank in 1928, he had been at sixes and sevens with government policy. In fact, once after receiving some instructions from the secretary of state in 1930, he had complained that “anyone would assume that the Imperial (Bank) was a department and a very inconspicuous department of the government”.

In a fit of anger, Sir Osborne had also once told the government that “as long as I run the Imperial Bank, I will not be run by London or anywhere else…I would not tolerate interference with my business”. In 1936, he had written in a letter that he was ‘sick to death’ of the government’s attempt to “dominate the RBI”.

But it was not only over the interest and exchange rates that Grigg and Osborne fought. There were two other issues. When Osborne opposed the gold drain from India and wanted to impose an export tax on gold, the government opposed him tooth and nail. Then, when Osborne wanted to appoint AD Shroff, an ICS officer, as deputy governor, Grigg dismissed the suggestion, calling Shroff “a perfectly frightful man and intimate crony” of Sir Osborne.

Overall, the British officers in India regarded him as a colonial who sympathised with the natives. All that could have still been ironed over, but when he called Viceroy Lord Linlithgow “a weak ass”, it was the last straw. He had to go.

So in July 1937, just two years after taking over as the first governor, he was forced to resign. Ironically, he had been appointed instead of some ICS officer or British banker, precisely to give the impression that the RBI was independent.

The British civil servants’ view of Osborne was coloured also by the fact that he was praised by Indian businessmen. The Indian Merchants’ Chamber wrote a very critical letter to Grigg after he resigned. And just as is happening now, the Congress demanded full disclosure.

The government simply remained silent hoping that the controversy would die down, which of course it did. But the episode left a very bad aftertaste, which has persisted till today, because nobody really knows what happened. As the late SS Tarapore, one of the greatest central bankers India has produced, had demanded, “The RBI owes it to posterity to release a dedicated volume on the Osborne Smith episode – warts and all.” It may show that nothing has changed. As now, then too the government wanted a subservient governor.

KR Puri’s rise and fall

Just how far control had moved from the RBI to the government came home to the RBI in 1975. The governor was a mild ICS officer called S Jagannathan who had managed to keep things on an even keel since 1970. But early in 1975, when political power in Delhi had become centred on Indira Gandhi’s son Sanjay, Jagannathan got a rude shock.

Sanjay, who started a car factory called Maruti, wanted the credit limit for his company to be increased. The RBI said this could not be done because Maruti was not compliant with existing rules for credit enhancement. It seems there were some sharp exchanges between Jagannathan, who was due anyway to retire in June 1975, and the finance ministry. He decided to leave a few weeks before his term was over. His critics said he had left because he was in a hurry to get to his next job as India’s executive director at the IMF.

Indira Gandhi used the opportunity to appoint KR Puri, the chairman of LIC, with no previous experience of banking, to the job. His first act was to raise the credit limit for Maruti – and for everyone else – without consulting his colleagues. The RBI, and, surprisingly, even the finance ministry fulminated, but there was precious little they could do. The Emergency was on and Sanjay Gandhi got what he wanted. No one dared to raise questions. In 1977, when the Janata government came to power, it removed Puri from the governorship within six months.

An interesting fallout of the Sanjay episode was that it led the RBI to move towards a “need-based” approach rather than a ‘security-based’ approach to bank credit.

By this time monetary policy had given way to credit policy or, more accurately, credit rationing. The idea was to ensure that credit reached those who “needed it most”.

The government decided who needed it most. The RBI didn’t like this. There was constant wrangling between the finance ministry and the RBI over credit rationing. The RBI was asked to behave when it tried to reassert itself. One of the worst culprits in this aspect was a government economist called Manmohan Singh.

Some incidents involving him are quoted below from the RBI’s official history:

... Manmohan Singh arrived in Bombay and bluntly informed the Bank's top executives that the government felt that there could have been “prior consultation” with them before announcing the credit policy on May 8.

...Krishnaswamy apprised Manmohan Singh over the phone of the measures proposed to be announced at the Governor's meeting with bankers on May 7. The latter shot back that the “Secretary desired that such matters from the Reserve Bank should be in writing”...This episode was a rude reminder that the Bank's policies could be formulated only with government's concurrence.

... Manmohan Singh, pointedly told the Bank “government would like the Reserve Bank to examine the matter on a most urgent basis for such action as it is considered appropriate in the direction of tightening credit against cotton”...The Bank issued a directive to the banks on July 08, 1976, raising the margins on raw cotton.

... Manmohan Singh had written to Krishnaswamy that as the FCI could not repay about Rs 250 crore to the government, and as the Budget for 1976-77 took credit for this amount, the Bank could arrange to provide FCI additional credit of Rs 250 crore...The needful was done.

Excerpted with permission from A Crown of Thorns: The Governors of RBI, TCA Srinivasa Raghavan, Mikros, Westland.