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RBI’s Impending Metamorphosis Will Test Our Claim To Be A Liberal Democracy

The only definitive outcome of the 10-hour RBI Board meet meeting was that the RBI is on the cusp of a metamorphosis. What path we choose to achieve this laudable metamorphosis in the RBI will determine the veracity of our claim to be a liberal democracy.


Is India a liberal democracy on the path to economic consistency? I had posed this question before the RBI Board meeting on Monday. Well, after the marathon ten-hour meet, it would seem we are indeed a democracy. Whether liberal, and on the path to economic consistency as well – only time will tell. 

The only definitive outcome of the meeting was that it put the RBI on the cusp of a metamorphosis. The manner in which this transformative event unfolds would be a delight to the world-renowned professors of the strategic negotiating class who taught us this elective at the Sloan Fellowship. A classic case study of wresting control of an institution whose mandate requires it to be totally independent of political pressures. This followed the classic “positional bargaining” format which involves each side taking an extreme position, veiled threats, heavy posturing and then, a few concessions to reach an agreement. Such negotiations become tense, drag on and generally lack both transparency and trust, whereupon the future of the relationship seems precarious. True to theory, of the five styles of negotiation, the “compromising style” works best in the positional bargaining format, which ensures a sub-optimal agreement, but is used to protect the ongoing relationship.  

The threat of invoking Section 7, along with the trial balloon for the transfer of reserves, were the starting points, apart from posturing by various arms of the government through media and twitter taunts. The three broad issues were an economic capital framework for the RBI, credit flow to the economy and governance of the RBI. A committee will be set up for the first; for the second a new scheme for MSME financing and the PCA framework will be revisited by an existing committee; finally, liquidity and governance issues were postponed till the next meeting. We will never know what transpired in those ten hours, but most experts believe that the outcome on these issues should not have taken more than an hour to resolve. This would indicate many substantive areas of divergence. 

Whilst having a difference of opinion is indeed healthy in a democracy, and whilst accepting that it is the sovereign right of a publicly-elected government to make changes, the fine distinction between “public interest” and “government interest” must be maintained and, more importantly, must be seen to be so. It is here that even apolitical commentators like me have reasons for some concern, for three reasons: the manner in which this has played out thus far in the context of the wide perception (I repeat ‘perception’)  of institutional interference by the government, the parachuting of an ideologue like Gurumurthy into the RBI Board along with the removal of a respected banker like Nachiket Mor, and the adhocism whilst inflicting momentous decisions like demonetisation (despite its positive impact on the much-needed liquidity surge to the NBFC sector and the ensuing credit flow to certain sectors starved of credit, due to the NPA stress of banks) on the country. 

Going by Arun Jaitley’s recent interview (which was most reasonable) I am sure that the government will adequately advise its nominees on the RBI Board to be wary of changing the basic terms of engagement of the RBI as a central bank with respect to its autonomy and legislated mandate. This is most important for the RBI to maintain its credibility and stature in the comity of central banks across the world – a hard-earned right gained over the last 70 years. Central banks like the Fed and the ECB are insulated from political interference by legislation and consequently, have ironclad governance structures. The Fed, for example, is run by board members who serve staggered terms of  14 years each and hence, no US President or Congressional party in the majority can control the board, even though the President appoints one member every two years. Trump, of course, is the first President in history to have questioned that independence lately and accused the Fed of being the greatest threat to growth − sounds familiar nearer home, but surely not company our leaders would like to be bracketed with! 

Similarly, Article 107 of the Maastricht treaty and Article 7 of the ESCB statute guarantee the independence of the ECB and allow it to take monetary policy actions based on fundamental economic reasoning, which many member states may consider politically inappropriate. Board members here are appointed for a non-renewable term of eight years and, like the Fed, are people with solid administrative experience in macro - economic management: central bankers, practising bankers, international financial policy makers with the IMF, Financial Stability Board, EBRD, etc. 

Such independence in a democracy necessarily is accompanied by accountability and transparency. The accountability framework for ECB or Fed Governors is stringent and multi-layered. In the ECB, for example, there exists a four-layer governance structure, and regular updates to the Committee on Economic and Monetary Affairs of the European Parliament to explain their reasoning on specific decisions. Furthermore, how supervisory accountability requirements are practised is also legislated in the Inter-Institutional agreement between the European Parliament and the ECB.  

Transparency is a key tenet of the accountability metric. Both these central banks have calendarised public communication protocols for explaining to the public their reasoning on strategy, assessments and policy decisions which ensures better public understanding of the interpretation of its mandate and policy goals. This makes policy more credible and effective by empowering market participants to rapidly implement changes in monetary policy into financial variables like investment, consumption decisions and other economic adjustments. Most importantly, this allows central banks to be open and realistic about what they can, and cannot, do. 

In this framework, adversarial positions between elected governments and the central banks are reduced significantly: ECB is a good example, while the US under Trump is not at the moment − and India needs to choose wisely. 

It is unquestionable that the RBI needs major changes in its governance and on many of the points stated above. For example, till 2016 even an MPC was not in place and all decisions on monetary policy were solely taken by the Governor and his team. This is not to suggest for a moment that the RBI has failed the nation, but the institutional imperative of having strong governance and decision-making structures cannot be over-emphasised. 

The government too needs to view this as an opportunity to make institutional changes in the way the RBI functions rather than exercise control over the institution. It needs to recognise that in such an evolving environment the RBI board needs to have a composition aligned to the new role being envisaged – people with a definitive level of competence, credibility and professional background for the onerous responsibility on the anvil in the new scheme of things. At the moment, it is far from reflecting the professional stature of directors in the Fed or ECB. Apart from Dr. Ashok Gulati, not even one nominated external director on the RBI is a trained career economist. Not to speak of the obvious conflict of interest some directors have, and have had in the past, of running organisations highly indebted to the banking sector, or those whose core business would be materially impacted by decisions of the RBI! This is because the RBI Act does not define the eligibility of directors on the board! 

I hope I am correct in my assessment that the last board meeting was one where mutual respect, restraint and building consensus were key themes, along with the resumption of communication and the genuine desire to build frameworks for taking decisions. Governance structures and guidelines for the composition of bodies chartered to implement them are prerequisites for a transition to a modern RBI. 

We must learn from the ECB and Fed amongst others like the BoE. These are mature democracies with decades of experience in building democratic institutions. Before twitterati troll these suggestions on the altar of nationalism, let us pause to think with the benefit of hindsight of a relatively younger nation, whether we can adapt their best traditions. 

At the core, this should not be about wresting internecine control over the RBI, but driving a glasnost and perestroika of the RBI’s architecture and decisionmaking framework. I am taking Finance Minister Jaitley at his word that the leadership of the government will be evident in its deep understanding of the issue and adherence to the norms of responsibility associated with its mandate. 

What path we choose to achieve this laudable metamorphosis in the RBI will determine the veracity of our claim to be a liberal democracy.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Prabal Basu Roy

The author is a Sloan fellow of the London Business School and a chartered accountant. He has previously been a director/ Group CFO in various companies. He now manages a PE fund and advises startups / corporates.

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