Urjit Patel’s shock resignation leaves the Reserve Bank of India headless, just a few days ahead of a critical board meeting. It is a fine gesture from a man who was likely driven to the end of his tether by a continuous campaign to erode the independence of India’s central bank. It is also probably a futile gesture because Patel’s exit leaves the Narendra Modi government free to do pretty much what it pleases.
It is a fluid situation but the government can easily justify the fact that it appointed a malleable person of its own choosing as the Governor: Shaktikanta Das. Das retired as Union Economic Affairs Secretary and was not only the face of demonetisation but has consistently continued to hail it as a success. A career IAS officer, he is not an economist by background but his unique selling proposition for the Modi government is that he can be relied upon to faithfully carry out the ministry of finance agenda.
In addition, the bank’s board has been systematically stuffed with the government’s “yes persons” who will go along what it desires.
In effect, the Reserve Bank will cease to be independent; it will be managed by the finance ministry. Acting through the board, or the interim governor, the government may implement any or all of the following:
- Transfer large sums out of the central bank’s reserves to plug the fiscal deficit or recapitalise bankrupt banks.
- Tell the Reserve Bank to ease the Prompt Corrective Action, or PCA, norms, allowing bankrupt banks to make loans as they please without repairing their damaged balance sheets.
- Carry out some new madcap scheme, perhaps another demonetisation.
- Perhaps, transfer a magical handout of Rs 15 lakh to every Jan Dhan Account via the Direct Benefit Transfer mechanism. (Remember the 2014 election campaign promise?)
- Or, print money in some other way as S Gurumurthy, one of the “yes persons” on the Reserve Bank’s board, has suggested.
The government needs to splash out on its 2019 election campaign. The damage caused by demonetisation and the disruption caused by the Goods and Services Tax and then by rising crude prices, has left the government’s finances in pretty bad shape.
The fiscal deficit this year is likely to expand well beyond the budgeted 3.3% of the GDP. It was already above the estimated mark by October. Indirect Tax collections are running well below the target as well. GST collections in the last five months of this financial year (November 2018 to March 2019) need to jump by about 45% above the current levels to meet the target. As many as 11 public sector banks are technically bankrupt and running under the PCA norms. Public sector banks own over 90% of the Rs 12 trillion or so of bad loans dragging down India’s banking system.
Not in the country’s best interests
In the absence of other sources of funding, the central bank’s reserves, amounting to Rs 3.6 trillion, are an obvious source of largesse for the government. (The central bank also has Revaluation Reserves of around Rs 9 trillion, but, in a sense, these are only notional since they consist of the revaluation of hard assets such as gold and forex.)
The government has an imperative to implement its agenda quickly, for the general election imposes a hard deadline. Whatever cash it chooses to distribute and however it chooses to do the distribution, it must work quickly to ensure the cash spreads through the system and sways voters.
The market will react badly to the turmoil, but Patel’s exit may help accelerate the tapping of reserves and the operational takeover of the central bank. The resulting damage to the system will be long-lasting, and the negative economic consequences will pull the economy back. But the Bharatiya Janata Party will accept that gladly as part of the price to be paid for another five years in power.
The consequences of the loss of the central bank’s independence could be much worse than most people can imagine. Governments frequently have imperatives – re-election, lining of pockets, handing out favours to cronies by forgiving loans – that are not aligned to the country’s best interests. An independent central bank can mitigate some of the more outrageous of these possibilities since it controls money supply and interest rates and can target what it deems to be a reasonable currency value. An independent central bank, therefore, also offers comfort to overseas investors who can hope for some continuity in the country’s monetary policy.
Absent an independent central bank, it is easy to envisage a scenario where the nation suffers either crippling recession or hyperinflation, caused by irresponsible government actions. To take a simple example, when the government is running a large fiscal deficit, it can cut interest rates to make its borrowing cheaper. Or, it can continue to run technically bankrupt banks as money dispensing machines for cronies. This has happened time and again, in places like Zimbabwe, Argentina, Venezuela.
Sadly, once the central bank loses its independence, it is unlikely to ever get it back. No political dispensation is likely to hand back control once it has got a grip on the central bank’s affairs. In that sense, it does not matter who wins the next election – the next government, the one after or the one after that will, at some stage, do some serious damage for its own short-term gains.
The Modi government has made a determined effort to take over operational control of the Reserve Bank of India. It started by not renewing Raghuram Rajan’s contract and continued by ramming demonetisation down the central bank’s throat (and Patel chose not to stand up against that lunacy). Along the way, the government steadily stuffed the bank’s board with appointees who can at best be described as Sangh Parivar ideologues with “eccentric ideas”. Patel’s exit takes the Reserve Bank further down the slippery slope to becoming just another glorified department of the finance ministry.