What’s the issue?
The Reserve Bank of India (RBI) and the government give the impression that they are not on the same page even as far as an understanding of their roles is concerned. The RBI suggests that its independence is being violated while the government rationalises its intervention in terms of its concern for the economy.
Functional autonomy
Even at the time when the idea of central bank independence began to germinate some two decades ago, this was understood to mean a ‘functional’ independence. That is, the bank would be unconstrained by the government in its functioning, which includes both the instruments it uses and how it uses them.
However, its autonomy was not to extend to ‘goal’ independence. What the goals of the central bank should be were to be chosen by the government without reference to the bank.
The main issue here was whether the bank should focus on inflation alone or also on the level of employment. Within a decade, it had been conceded that the focus would be exclusively on the former, and In 2015 the RBI was by law, in line with a “modern monetary policy”, expected to target inflation.
Fed reserve: maximizing employment and stable prices
Issues of contention
- Corrective action to be taken for stressed banks
- Prudential norms to be adopted by financial institutions
- Easing of liquidity
- Sharing of the surplus generated by the RBI.
Of sharing surplus
Government of India legally is the owner of the surplus generated by the country’s public institutions. Even under this architecture, though, all care must be taken to ensure that the central bank’s reserves are of a level commensurate with the extent of the financial sector and the potential degree of systemic risk from its malfunctioning, which can vary. So, we can’t go just by formulae here.
On other issues
GoI plays vital role in selections of Governor and his deputies, it also has representatives in the board. It would therefore only be prudent to leave to this body to decide on the precise corrective action for banks with high NPAs, the desirable state of liquidity and the prudential norms to be observed by banks. The RBI is the banking regulator after all, and for the government to attempt to direct it would constitute micro-management.
Stability of the economy
While acting as the lender of last resort can be stabilising, under no circumstances would it be advisable to lower prudential norms in the presence of stressed banks. The government’s concern for the health of the medium and small enterprises is well-founded, after demonetisation. The right course would be interest subvention, rather than tweaking lending norms as proposed under online sanction within an hour.
The Central bank’s independence and targeting of inflation has brought no good either. Over 2013-2018 there has been a 5 percentage point swing in the real interest rate in India, moving from a negative to a positive level, making it among the highest in the world, much higher than that of China. It may well have contributed to slow industrial and export growth, due to a real appreciation of the rupee, and a rise in NPAs even after their existence had been recognised.
Enabling job creation
While it would be bad economics to tolerate high inflation, the absence of inflation by itself only benefits those in employment, it does not assure jobs to the unemployed. Thus a monetary policy that ignores the impact of its actions on unemployment is not credible.
In conclusion
The populist message that inflation erodes the income of the poor conceals the possibility that in the implementation such a policy could hold back job creation by restricting investment.
The rising current account deficit, the slow growth of employment and the disappointing performance of manufacturing, the sector most closely affected by high interest rates, should prompt us to review how monetary policy is conducted in India.
In the past, the RBI had a ‘multiple indicators approach’ which paid attention to inflation, growth and the current account. This may not have borne the precision conveyed by ‘inflation targeting’ but it did answer to Keynes’s dictum, “It is better to be vaguely right than to be precisely wrong.”
