Let us not mince words. One reason for the government changing the RBI Governor is to get a more pliable candidate who will help it win the general election in May 2019. There are also other technical issues on which former Governor Urjit Patel had locked horns with Finance Minister Jaitley. Much has been written about the technical issues, but not enough about the electoral connection.
The BJP’s defeat in last week’s state elections highlighted its vulnerability in the 2019 general election. Narendra Modi came to power promising “achhe din” through plentiful jobs created by faster economic growth. Alas, job growth has been modest and GDP has not accelerated significantly. Voters are sourly anti-incumbent. The BJP needs a last-minute economic spurt to improve its electoral chances.
One gambit is to flood the economy with plentiful cheap credit. A second is a populist government spending spree, financed by grabbing a big chunk of the RBI’s reserves. Urjit Patel resisted these approaches strongly and resigned rather than succumb. He deserves high applause for principled courage even from those disagreeing with his economic views.
His successor, Shaktikanta Das, is a former finance secretary who had presided over demonetisation and the launch of the Goods and Services Tax. His good relations with Jaitley undoubtedly helped him get the RBI job. The stock markets have boomed, since they expect Das to follow the Jaitley-Gurumurthy line of expanding credit sharply, especially to small and medium enterprises. Markets also anticipate a pre-election spending spree by Jaitley, aided by a transfer of RBI reserves, which could quickly boost sales, profits, jobs and perhaps the BJP’s vote share.
But will this be good for India in the longer term? Past lending sprees have ended in massive bad debts and bust banks. The rationale for an independent central bank is that politicians focus narrowly on short-term issues, so countries need strong, independent institutions with long-run perspectives that can rein in short-term political excesses. And so governments bind their own hands by creating independent central banks to check their own shortterm populism. Replacing Patel may yield shortterm gains but add to long-term woes. It will erode the institutional strength vital for liberal democracy and economic growth.
Neither is the RBI always right nor politicians always wrong. Central bankers sometimes make terrible blunders. That does not diminish the need for an independent RBI. The courts also make some terrible judgements, but we still need an independent judiciary.
An independent RBI must be accountable. But not to the RBI Board, which includes politicians, bureaucrats, civil society members and businessmen, who lack technical expertise and may have vested interests. Board members should advise but not control the RBI Governor. Nor should the RBI be accountable to the finance ministry, since one of its tasks is to check finance ministry short-termism. The Governor should be accountable to, and dismissable by, the Prime Minister. That will be a good combination of independence and accountability.
Das says the RBI should be autonomous but accountable. He promises to talk to all stakeholders before acting. Very good, but will he show enough spine? Will he stand up on at least some policies Patel opposed, such as transferring massive RBI reserves to the government, relaxing lending curbs on zombie banks (technically called PCA banks), releasing more money for non-banking financial companies, and diluting capital requirements for banks?
I agree with the finance ministry that the RBI has kept real interest rates too high for too long. However, bank credit has been growing at a good 15% this year, so a new flood of money may finance dubious rather than good ventures. Das should not quickly part with RBI reserves to finance a budgetary spending spree. A committee is supposed to decide what precisely constitutes excess reserves meriting transfer. This should be a technical, not political exercise. Das should try to ensure that most committee members are experts, not politicians, businessmen or bureaucrats.
The banking system is littered with bad loans (to Mallya, for instance) and flawed lending practices (as to Nirav Modi). RBI’s emphasis must be to raise lending and monitoring standards, not launch a loan bonanza, risking another round of bad debts. Rating agency ICRA estimates that 11.2% of PCA bank loans are non-performing, and that they will lose Rs 49,000 crore this year. More healing is required before declaring this patient ready to go.
Jaitley avoided a populist spree in his 2018 budget, saying elections could not be bought with freebies. Alas, the RBI drama suggests he may reverse course in his last budget. He would do better to hold firm.