RBI governor quits, defying government diktat. Successor complies. The year? 1957

The upheavals of the twenty years between 1950 and 1970 would change...[the RBI] forever, from being a mere manager of the monetary system to an active participant in the development effort. It was asked to get off its high pedestal and wade in, as it were, into the messy work of getting a whole country going. It did, in a rather ill-tempered sort of way to begin with and then with more grace and cooperation.

Looking back, there really wasn’t much for the RBI to do for most of the 1950s. For the most part, it carried out routine functions, emerging in the process as a genuine central bank via control over the issuance of currency and manager of government debt. Its role in banking supervision was defined by the Banking Regulation Act of 1949. On the whole, the 1950s passed quietly enough.

India was still a very open economy throughout the 1950s and monetary policy did pose a problem because of rising prices and depleting foreign exchange reserves.

The RBI had to manage inflation and reserves and it did so quite creditably – until the Second Plan came along, when it ran full tilt into conflict with the government.

But between 1951 and 1957, the only significant thing of note was the departure from the policy followed since 1935 – of keeping the bank rate steady at three per cent. But alarmed by the possibility of inflation, in November 1951, it was raised to 3.5 per cent and resulted in the commercial banks increasing their lending rate to four per cent. The RBI also decided to stop buying government securities, after the government had agreed that it could do so. This, too, was a major departure from the previous fifteen years.

There was one new thing, however, that the RBI ventured into, an area no other central bank had, or has: rural credit. The RBI Act of 1934 had enjoined it to expand credit to agriculture because India was so predominantly agricultural. But the British had no particular preference for this – certainly not as much as independent India would have – and little effort was expended on expanding bank credit to farmers. Why bother when they could not repay?

Even the appointment of CD Deshmukh as governor in 1943 did not bring about much of a change in attitude. To be sure, it had periodically set up committees to “look into” the problems of rural credit. But it was Deshmukh’s successor, Sir Benegal Rama Rau, who started pushing for it. The first All India Rural Credit Survey was carried out in 1951 and 1952 and published in 1953.

It was a valiant effort but came to nothing much because of a whole host of problems regarding the quality of the data collected and the methodology used. But there were two pieces of lasting harm it did: it brought the government and the RBI into the cooperative movement and it led directly to the nationalisation of the Imperial Bank which became the State Bank of India.

There was a great deal of intellectual as well as political support for it at the time but criticism, too. Not unnaturally, the RBI’s own subsequent and current assessment has been very positive and even self-congratulatory. The second volume of the official history of the RBI speaks in very laudatory terms of the efforts made by the RBI. The truth, however, is that the rural credit problem has still not gone away and the SBI has, of course, become a handmaiden of successive finance ministers.

But an even larger failure was lurking just round the corner.

...The government was anxious to step up the investment rate to get on with industrialisation. Congress members had been vocal in their demands for it. [Prime Minister Jawaharlal] Nehru was under pressure to start delivering. So in 1956, at Avadi the Congress decided to become the primary agency for promoting industrialisation.

The Second Plan was launched the same year and it was predicated on an economic unorthodoxy: deficit financing, which meant that the government would spend substantially more than it earned in order to invest in heavy industry, which was the leitmotif of the Mahalanobis Model. And this brought the RBI into direct conflict with the government. It lost the battle, as decisively as it has every battle since then.

There are two versions of the story, one told by the official history of the RBI and the other by BK Nehru, who was the all-powerful joint secretary in the finance ministry at the time. The governor was Sir Benegal Rama Rau, an ICS officer of impeccable credentials. The finance minister was TTK [TT Krishnamachari] who not only thought that he knew everything but also that no one else knew anything.

TTK had been treating Rama Rau with scant respect, who complained at least thrice to the prime minister about TTK’s “rudeness”, “rude language” and “rude behaviour”. Once TTK even announced a monetary policy in Rama Rau’s presence, which was different from what the RBI was going to announce.

But what proved to be the last straw was the announcement by TTK of a stamp duty on bills. He refused to acknowledge that it was a revenue measure and wouldn’t even tell Parliament. TTK said he wanted a cheap money policy and also maintained that the duty, which was bound to raise the lending rate, was a credit control measure. How both could be true, he did not deign to explain.

Rama Rau and others tried to dissuade TTK, to no avail. TTK even told Parliament that the proposed hike was a “fiscal measure with a monetary intent”! This led Rama Rau to write a letter in which he said that henceforth “two authorities would operate the Bank Rate.”

Finally, the matter went up to Jawaharlal Nehru, and a meeting was called in the cabinet room to discuss it. TTK and Rama Rau came face-to-face outside it, and, according to BK Nehru, TTK ‘let fly in no uncertain terms and in the loudest of voices’. He made it clear that the RBI was a “department” or “section” of the finance ministry.

Rama Rau immediately resigned but was persuaded to stay on by Jawaharlal Nehru and GB Pant, the Home Minister.

But TTK’s attacks on him and pressure on the RBI continued.

Eventually, Nehru sided with TTK. He wrote to Rama Rau that the RBI was “obviously a part of the activities of the government... and has to keep in line.” Rama Rau said he would have to resign and Nehru’s response was short and curt: ok, go if you must. “If you wish you can send your formal resignation to the Finance Ministry.” Only a little earlier he had written to Vaikunth Lal Mehta (the cooperatives leader) that the RBI had to have its autonomy! So much for that.

Rau was succeeded by Sir HVR Iyengar. TTK’s view, expressed forcefully to Rau that the RBI was no more than a “subordinate department of the finance ministry”, was well understood by him. Under him and his successors, the RBI didn’t make any fuss about deficit financing or, indeed, about anything. Even when fourteen banks were nationalised, virtually overnight, by Indira Gandhi in 1969, the RBI merely sighed and accepted that the new department of banking would be the real boss.

It had its differences of opinion which were expressed in long and lugubriously polite letters. But in the end, it did what it was told – just as it has always done since the time that Osborne Smith was sacked.

Excerpted with permission from Dialogue of the Deaf: The Government and the RBI, TCA Srinivasa Raghavan.