‘I hate to see you go but I love to watch you leave’ might sum up the sentiment in the current administration now that RBI governor Urjit Patel has resigned. Autocratic regimes like it when their minions are at their beck and call. That Patel developing a mind of his own didn’t bode well was a foregone conclusion, despite the papering over contentious issues at the last RBI board meeting. While Patel’s resignation has evoked sharp reaction from economists, the opposition has promptly used the development to heckle the government, pointing out how the present regime is systematically destroying institutions.
Without a doubt, the Reserve Bank of India (RBI) has been one of most respected central banks in the world. It has steered the economy through turbulent times over several decades. Despite crony capitalism and fiscal imprudence by successive central and state governments, if the country has still not seen a run on its currency or hyperinflation, it is because the bank has by and large been governed by prudent policies and independent action.
It is not that the apex bank was never arm-twisted by the government anytime in the past. Over the past couple of decades, including during the Congress regime, there has been tension between the central bank and the government over steering interest rates. But, the differences remained confined to monetary policy. In the absence of enough fiscal headroom, due to the constraints posed by the Fiscal Responsibility and Budget Management Act (FRBM), and the failure of successive governments to radically alter tax collections, the easy way out was to goad the central bank towards an easy monetary policy.
Since governors of central banks were usually deputed from the finance ministry, they were already prepared to view the big picture from both the government’s point of view and the prism of Reserve Bank’s key objectives. Under UPA-I, the spat between governor YV Reddy and finance minister P Chidambaram had been widely known. But, in the aftermath of the 2008 crisis, Reddy’s conservative stance was commended as thoughtful and one of great foresight.
But this time, if the tension between the government and the apex bank has been stretched to the limit, it is because the calculation around the “draconian act” the Narendra Modi government implemented did not work out. Hailed as Modi’s master move to end black money and address the issue of fake notes, demonetisation was not expected to bring back the entire sum outstanding against the apex bank’s liability (Rs.15,400 billion) driven by fear of people getting enmeshed in the tax net or harassment by tax authorities.
If that had happened, it would have allowed the apex bank to forfeit its liability by a substantial amount, a few thousand billion, which if transferred to the government as a one-time dividend could have allowed the Modi government to go on an extravagant spending spree to lift the economy, bring in “achhe din” and use it to political advantage over the rest of its term.
The plan bombed miserably. With demonetisation garnering nearly the entire sum against its liabilities, there was nothing left to take away. And all that the scheme garnered was the wrath of the marginal folks - a substantial segment of the voting population, and an Rs.80 billion expense in FY17 in the apex bank’s book for printing the new notes.
The government’s demand now for transfer of Rs.3,600 billion from its reserves is nothing but Plan B, in the event of failure of demonetisation. More so, the government did not get any luckier with the economy. While business went through a challenging period because of Goods and Services Tax (GST) implementation, the reform failed to bring in the projected tax collections. A paralysed banking system has continued to lull the economy, and global economic headwind has not helped either.
This year, an already precariously poised economy got a further blow on account of the liquidity squeeze following the IL&FS crisis. With the government running out of ammunition to lift sentiment in an election year, the bulldozing by the government is unsurprising. This year, the government has already exhausted much of its borrowing limit and further borrowing will result in further fiscal slippage, damning for its reputation as an economically-savvy government, more than anything else.
While Patel, who was seen as pliable during demonetisation, had been resisting the government’s overture, he did yield to relaxing capital adequacy norms for banks to ease the liquidity squeeze last month. But then, the two contentious issues of transfer of surplus reserves to the government and easing of lending restrictions to weak banks have been referred to separate committees. While the finance minister Arun Jaitley has claimed that the government does not need the reserves in the next six months, probably expecting to prepare the ground for the next term, the results of the recent state elections are an indication the government will need the money much before that.
With hurdle Patel gone, being a government appointee, and with such pressing and immediate issues, the next governor will be someone willing to walk the government’s talk, and come with a 100-day action plan. That does not of course ward off the possibility of the RBI board taking an operational role in the functioning of the apex bank. Which of the two outcomes is better is only a matter of conjecture.