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In a speech, the text of which was posted on the RBI website, Acharya also said that policies should be "rule-based".
"To ensure greater financial and macroeconomic stability, these efforts must be extended to give the Reserve Bank effective independence within its regulatory and supervisory powers over public sector banks", he declared.
His comments come from the government's efforts to create a separate regulator for the country's payment system – which is currently managed by the RBI as part of its banking regulatory functions.
Government officials also asked the RBI to ease credit restrictions for some banks with low equity.
The attack on the independence of the central bank was "potentially catastrophic" and could "trigger a crisis of confidence in the capital markets," Acharya said.
Indian financial markets have been in turmoil since September due to a series of recent failures on the part of Infrastructure Leasing & Financial Services (IL & FS), one of the largest finance companies in the world. Infrastructure, which has raised concerns about the health of the entire shadow banking sector. .
While the government and the RBI have taken several steps to limit the impact of these failures by replacing the board of directors of the company and increasing banks' funding limits for non-financial corporations banks, investors remain skeptical.
Referring to non-bank financial corporations, Acharya said that systemic risks can accumulate in the shadow banking system when large parts of financial intermediation are excluded from the central bank's jurisdiction, which could lead to "substantial costs for future generations". uncontrolled financial fragility ".
"The independence of the Reserve Bank has remained a work in progress, a persistent challenge that the country faces on a continuous basis," he added.
Here is the full text of Acharya's speech:
No badogy is perfect; however, badogies help to make things better understood. Sometimes a straw man must be set up to succinctly a practical or even academic point. However, sometimes concrete examples come to the fore in order to facilitate the work of a communicator. Let me start today with an antecedent of 2010, particularly relevant to the theme of my presentation:
"My time at the central bank is up and that's why I'm here. I decided to definitely leave my post, with the satisfaction of my duty being fulfilled, "said Friday, January 29, 2010, Friday, January 29, 2010, Mr. Martin Redrado, head of the Central Bank of Argentina, at the 39; AFP.
"We have arrived at this situation because of the permanent trampling of institutions by the national government," he said. "Basically, I defend two main concepts: the independence of the central bank in our process of decision-making and the fact that the reserves must be used for monetary and financial stability. "
The consequences of this spectacular exit are an emergency decree adopted by the Argentine government led by Cristina Fernandéz on December 14, 2010 , which would create a bicentennial fund for stability and debt reduction to finance the public debt maturing that year.This involved transferring $ 6.6 billion from the central bank's reserves. The badertion was that the central bank had "excess reserves" of $ 18 billion. [In fact, Mr. Redrado had refused to transfer the funds; so the government attempted to fire him, by another emergency decree on January 7, 2010 for misconduct and dereliction of duty; this attempt, however, failed, as it was unconstitutional.]
In addition to the As a result of one of the worst constitutional crises in Argentina since its economic collapse in 2001, the chain of events has led to a serious rebadessment of its sovereign risk.
One month after the resignation of Mr. Redrado, Argentine sovereign bond yields and the cost of annual premiums related to the underwriting of insurance against the default of Argentine government bonds (measured according to swap spread on sovereign credit default) increased by about 2.5% or 250 basis points, more than a quarter of their previous levels
Alberto Ramos, Argentinian badyst at Goldman Sachs , said on February 7, 2010: "Using the central bank's reserves to pay the government's obligations is not a positive development. and the concept of excess reserves is certainly subject to debate. It weakens the balance sheet of the central bank and is a misguided incentive for the government, as is the incentive to control the rapid expansion of spending and to promote some consolidation of the fiscal accounts in 2010. "
Even more prejudicial, a risk that Governor Redrado had warned was on the agenda.In early January 2010, Thomas Griesa, a New York judge, had frozen the account of the Argentine central bank at the Federal Reserve Bank of New York, following investor statements claiming that the central bank was no longer an autonomous agency but under the thumb.
(The above summary is based in part on the resignation of the head of the Argentine central bank, Jude Webber, Financial Times, January 30, 2010; and on Argentina: the independence of the bank is at stake at the exit of Redrado, Jason Mitchell, Euromoney., February 7, 2010)
This inter complex action of the exercise of the powers of the ruler, the exit of the central bank and the revolt of the markets will be central to my remarks today about its importance for the proper functioning of an economy have an independent central bank, ie a central bank independent of the executive branch of the government. I will also try to explain why the risks to the independence of the central bank are potentially catastrophic, a "personal goal", insofar as this can trigger a crisis of confidence capital markets that is exploited by governments (and other private sector actors).
Why do nations succeed (or fail?)
Before addressing this complex game, I want to place the independence of the central bank in a more general context.
Academic Discourse Political economists recognize the key role played by the rule of law and the responsibility of governments to enable countries to flourish. Francis Fukuyama (Origins of the Political Order, 2011) believes that these two elements, as well as the adequate strengthening of public authorities and institutions, are essential for "going to Denmark" or, in others create stable, peaceful, prosperous and inclusive conditions. and honest companies.
Daron Acemoglu and James Robinson (Why Nations Fail, 2012) summarize their work on the primacy of the quality of institutions to explain the success or political and economic failure of states. Taking examples of case studies of "twin" countries (such as South Korea and North Korea), the book makes the following important distinction:
– Inclusive economic and political institutions involve decision-making to plurality, which contributes to guaranteeing the right and promoting talent and creativity; in the presence of such institutions, the economy and politics do not become hostages to a group of incumbents likely to undergo change.
– In contrast, extractive institutions limit elite access to power to the economic and financial resources of a country. change and innovation, and over time, lead to stagnation and atrophy of the country's potential.
In conversations with former colleagues at New York University's Stern School of Business (NYU Stern), it was common to categorize economies as encouraging and supporting one or the other. l & # 39; other. The creation of value, which encourages entrepreneurs to believe that their success rests on the questioning of orthodoxy or rent extraction, in which companies find their interest mainly in s & # 39; badociating with the regressive policies of the state and evicting those who do not have access to it.
the importance of institutions, it is well understood that they include, among others, property rights and their childhood. Public order, the judiciary and the electoral office in a democracy have not been established by law but allowed to function independently and de facto.
The institution of an independent central bank is a little less celebrated, perhaps not only The bank is a relatively new player in the neighborhood (in most cases, less than a century old) but also because it interacts less directly with the public, although its true influence is far-reaching.
The Government and the Central Bank – A Tale of Two Horizons
A central bank performs several important functions for the economy: it controls the money supply; sets the interest rate on borrowing and lending money; manages the external sector, including the exchange rate; oversees and regulates the financial sector, including banks; it often regulates credit and foreign exchange markets; and seeks to ensure financial stability, both domestically and externally.
Around the world, the central bank is created as an institution separate from the government; In other words, it is not a department of the executive function of the government; its powers are consecrated as being separated by the relevant legislation. Because its tasks are somewhat complex and technical, central banks are ideally led by technocrats or field experts – usually economists, academics, commercial bankers and sometimes private sector representatives, appointed by the government but not elected . This architecture reflects the acceptance of the thesis that central banks should be allowed to exercise their powers independently.
Why is the central bank separated from the government? I will explain what I find to be a particularly intuitive explanation:
(1) The first part of the explanation concerns the decision-making horizon of a government relative to that of the bank Central.
The decision-making horizon of a government is shortened, similar to the duration of a T20 match (to use a complex badogy), by several considerations. There are always imminent elections – national, regional, mid-term, etc. With the approach of the elections, the presentation of proclaimed manifestos of the past becomes urgent; when manifestos can not be executed, populist alternatives must be arranged with immediacy. Less important in the current scenario, but only recently, wars had to be waged, financed and won at all costs. This myopia or short-termism of governments is well summarized in the history of Louis XV when he proclaimed "After me, the flood!" (2).
In contrast, a central bank plays a test match. , trying to win each session, but most of all survive to have a chance to win the next session, and so on. In particular, the central bank is not directly subject to the pressures of political time and the induced negligence of the future; By virtue of their appointment rather than their election, central bankers have decision-making horizons that tend to be longer than those of governments, covering election cycles or periods of war. While they must clearly take into account the immediate consequences of their political decisions, central bankers can afford to pause, reflect and ask themselves what the long-term consequences of their policies would be. than those of the government. Indeed, in their mandate, central banks have committed to stabilizing the economy throughout the economic and financial cycle and must therefore look to the medium-term. Unsurprisingly, central banks seek to strengthen their credibility through a series of difficult choices reflecting sacrificed sacrifice of short-term gains in favor of long-term outcomes such as price stability or financial stability.
(2) The second part of the explanation The bank is distinct from the government because it largely observes what the central bank manages or influences – monetary creation, credit creation, external sector management, and stability – has potential benefits for the economy, but with the possibility of "marginal risk" in the form of costs attributed to excess or financial instability. For example,
(i) A larger money supply can facilitate financial transactions, including the financing of fiscal deficits, but can lead to overheating of the economy in a timely manner and trigger (hyper) inflationary pressures or even generalized crisis possibly requiring more marked monetary contractions;
ii) Excessive interest rate cuts and / or a relaxation of banks' capital and liquidity requirements may lead to increased credit creation, badet price inflation and the appearance of strong growth In the short term, however, excessive credit growth generally accompanies a reduction in the quality curve, which triggers poor investment, badet price ruptures and long-term financial crises. ;
iii) allowing foreign capital flows to infiltrate the economy can temporarily alleviate the financial pressures on an expanding public balance sheet and the saturated private sector, but a "sudden stop" or an exodus of these flows in the future can trigger exchange rate collapse with negative spillover effects on the economy as a whole; and,
(iv) Reducing losses on bank loans by compromising supervisory and regulatory standards may create a short-term financial stability front, but will inevitably result in the collapse of the fragile card game. future, probably with a higher taxpayer bill and a potential loss of output
Although this is not always the case, the interventions required for stable growth are often structural reforms of the government involving an initial budgetary expenditure; however, this may compromise populist spending or require displaced incumbents. As a result, it may seem like a timely solution for the government to ask / give a mandate / to direct the central bank to pursue strategies that generate short-term gains, but actually create extreme risks for the economy. To protect the economy from this short term, the central bank is designed to be at a safe distance from the executive branch of government.
Breaching the Independence of the Central Bank
At present, although the central bank is officially organized so as to be separated from the government, its actual decision-making horizon can be reduced for the government to draw short-term gains, if desired, through various mechanisms, including,
Appointment of government (or affiliated officials rather than technocrats to key positions in the central bank, such as governor , and more generally senior executives;
Continue progressive destruction of the statutory powers of the central bank through ad hoc legislative amendments that nibble directly or indirectly separation from the central bank of the government;
Block or s & Oppose rules-based central bank policies and favor discretionary or joint decision making with n direct government intervention; and,
Establishment of Alternative Regulatory Bodies with Lower Legal Capacity and / or Encouraging the Development of Unregulated (or Lowly Regulated) Entities Performing Financial Intermediation Outside the Boundary Jurisdiction Centrale., 3 4
successful, they induce political myopia in the economy, which substitutes macroeconomic stability for the punctuated arrival of financial crises.
Therefore, there are several reasons why rooting and maintaining the independence of the central bank is an inclusive reform of the economy; and conversely, undermining this independence as a regressive and extractive society:
When the government is often striving to dilute the central bank's policies and effectively force the central bank to dilute them, the banks and the private sector spend more time. time to put pressure on them individually, at the expense of the collective good, rather than investing in value creation and growth.
When the governance of the central bank is compromised, it is unlikely to attract or retain the brightest minds that leverage the ability to freely debate, think independently and make changes; The attrition of the central bank's powers leads to the attrition of its human capital and the deterioration of its efficiency and expertise.
When important parts of financial intermediation remain outside the central bank's field of action, systemic risks may develop in the shadow banking system. "With private gains in times of prosperity for a small group of actors but with substantial costs for future generations in the form of uncontrolled financial fragility.
As such, the divergent horizon of decision-making between the government and the central bank emphasized that nothing leads to operational incompatibility as long as it is well understood and accepted by both parties. parties that it is precisely, given this discrepancy, that the central bank is officially separated from the executive board and that it is supposed to perform its functions effectively. independently. Of course, the central bank can make mistakes and is generally held accountable to the public through parliamentary oversight and transparency standards. Thus, institutional arrangements for independence, transparency and accountability to the public not only balance but also strengthen the autonomy of the central bank. However, direct intervention and government interference in the central bank's operational mandate undermine its functional autonomy.
"The kiss of death" – engulfing in the anger of the markets
Farsighted government leaders might perhaps reap the rewards of convincing voters of the importance of investing in macroeconomic stability; for example, by claiming credits for the long-term nature of financial sector results achieved by granting the central bank autonomy in decision-making and the performance of its core functions. When such a measured perspective of an independent central bank as a key element of a sustainable economic prosperity is missing and / or that a myopia of government is such that it leads to regular incursions into the apparatus and the decisions of the central bank, unfortunate accidents can occur. Macroeconomic management can become a tug of war between security and stability. daily operational decisions lead to power struggles; and, while the central bank is forced to go out of its way to maintain its credibility in the face of looming pressures that would erode its independence, thwart efforts to reduce its independence.
As this momentum materializes, the markets are watching closely, and if uncertainty grows and confidence in the independence and credibility of the central bank erodes, then markets correct bond yields and the exchange rate!
Let me clarify.
Modern economies are not usually autarkies; they rely on capital markets to finance their investments. This is particularly true for governments, as evidenced by the relatively large size of the sovereign (and quasi-sovereign) debt markets, denominated in national currency as well as in foreign currency. As long-term risks, such as inflation or financial instability, increase, markets replenish sovereign debt and potentially run out of funding. This could have immediate repercussions on other markets, such as foreign exchange and foreign investment, potentially jeopardizing the stability of the external sector of the economy.
Therefore, the presence of this third player – the market – in both directions between a government and the central bank (more generally the regulatory institutions) is an important feedback mechanism. The market can discipline the government not to undermine the independence of the central bank, and can also charge the government for its transgressions. It is interesting to note that the market also forces central banks to remain responsible and independent when it is under government pressure5.
In addition to the market revolt and the restrictions imposed during the Argentine episode of 2010 that I have recounted in my introductory remarks, it should be noted that this year the collapse of sovereign bonds and emerging market currencies was catalyzed by the perception of the government's influence on the central bank's monetary policy, including sporadic government communication with the public about its desire to control the bank's decision-making process. Central. In one case, a reduction in rates following the rise in inflation and the rise in the budget deficit had adverse effects; and in the other, it was a public statement by the prime minister, the "ills" of rising interest rates, even when inflation was at two. figures.
Indeed, market censorship does not have to be limited to emerging markets. The public expression of the government's confusion and disappointment at the monetary tightening of the world's largest safe-haven economy, still in a context of rising inflation and budget deficits, has evoked the scenarios investors in whom the status of reserve currency could no longer be taken for granted. (A debate on the independence of the central bank is long overdue, The Economist of October 20, 2018.)
Barry Eichengreen, professor of economics and political science at the l. University of California at Berkeley, superbly covers his recent article (2018). , this critical role of market reaction:
"There are good reasons why countries … delegate their monetary policy decisions to technocrats appointed for their expertise. They can have a long-term vision. They can resist the temptation to manipulate monetary conditions for short-term gain. As history shows, focusing on long-term stability is good for economic performance. And it is on this performance that elected leaders, rightly or wrongly, are judged.
Reflective politicians understand this. Hence their support for the independence of the central bank and their compliance with the convention that they should refrain from seeking to influence the decisions of the central bank. Unfortunately, not all politicians are caring. All do not have the patience to wait for long term gains. Not everyone is happy when the appointees refuse to comply with their wishes. And not all of them respect the inherited conventions and institutions, whether it is the independence of the central bank or, more generally, the division of powers.
The question is whether they are paying attention to the markets. "
What Barry Eichengreen observes with insight is that if a government were paying attention to the markets, it would realize that the independence of the central bank is in fact its strength and that the central bank is a a kind of true friend, someone who will tell the government unpleasant truths but brutally honest and correct as far as possible it can have long-term negative consequences on government policies.
Now let's see how all this is linked to the Reserve Bank of India.
The death of Deena Khatkhate is a masterly and scholarly evaluation of the Reserve Bank of India: A Study on Separation and the Attrition of Power (2005). The discussion below is based heavily on its evaluation and is updated to reflect developments since then: The debates of C. Rangarajan (1993) and YV Reddy (2001, 2007) , former governors of the Reserve Bank of India, also discuss the autonomy and independence of the Central Bank in the Indian context. As we will see below, other governors and deputy governors have also worn this faithful theme throughout their tenure. For some of them, even when the independence of the Reserve Bank was uncertain de jure, the governments finally had the wisdom to support de facto; for others, however, the independence of the Reserve Bank has remained a work in progress, a persistent challenge that the country faces on an ongoing basis.
Progressive Evolution in the Restoration of the Independence of the Reserve Bank of India
The Reserve Bank has always drawn several important powers from the 1935 Reserve Bank Act and the 1949 Act. the regulation of banks. What matters is the effective independence with which these powers can be exercised in practice. Over time, successive governments, at the request of the central bank, many economists and numerous committee reports, have made great strides in restoring the operational independence of the Reserve Bank. I will address three of these areas of healthy progress.
(1) Monetary Policy: Like many central banks of the day, the Reserve Bank soon became trapped in the socialist planning policy of the post-independence government. interest rate on the currency, but virtually all credit rates at different maturities, as well as the sectoral allocation of credits to the real economy.
After the deregulation of interest rates in the 1990s, monetary policy acquired a more modern dimension. For starters, there was a "multi-indicator" approach to setting interest rates. Having too many objectives for monetary policy violates Tinbergen's principle that "an objective, an instrument"; cela rend également difficile la compréhension ou la communication de ce que le taux d’intérêt tente d’atteindre à tout moment. Il est important de noter que cette approche laissait beaucoup de marge de manœuvre aux autorités réglementaires, souvent au niveau individuel. le gouverneur de la banque de réserve. Cela a rendu l’indépendance de la politique monétaire spécifique; en d'autres termes, cela permettait au gouvernement de faire pression de manière à maintenir facilement les taux bas en période d'expansion fiscale sous une forme ou une autre.
Il s'agit exactement d'un cadre dans lequel les règles seraient meilleures que le pouvoir discrétionnaire, en particulier pour éviter la problème d'incohérence dans le temps, mis en évidence dans les travaux des lauréats du prix Nobel Finn Kydland et Edward Prescott dans les années 1970 et au début des années 1980. Kydland et Prescott (1977) considèrent que les citoyens, y compris les investisseurs, pourraient envisager l'avenir et anticiper le comportement de gouvernements intéressés, de sorte qu'une politique monétaire discrétionnaire puisse être compromise par les pressions des gouvernements, laissant sans espoir les anticipations inflationnistes. considérant qu'une politique monétaire résolue serait plus difficile à contrecarrer et à contenir les anticipations inflationnistes.6
Après plusieurs périodes épisodiques d'inflation à deux chiffres, une guerre contre l'inflation et des anticipations inflationnistes, a finalement été lancée en septembre 2013 par le puis gouverneur Raghuram G Rajan; le rapport du comité Urjit Patel sur la révision et le renforcement du cadre de politique monétaire a été publié en 2014; et, enfin, la loi relative à la Reserve Bank of India a été modifiée en août 2016 pour constituer le Comité de politique monétaire (MPC).
Le MPC est composé de trois membres de la RBI, dont le gouverneur qui dispose d'une voix prépondérante et de trois membres externes nommés. par le gouvernement. La MPC s'est vu confier par la loi un mandat flexible de ciblage de l'inflation consistant à atteindre une inflation de 4% de l'indice des prix à la consommation (IPC) à moyen terme, tout en prêtant attention à la croissance, avec une indépendance opérationnelle pour la réaliser et une transparence en matière de transparence. Résolution du MPC, procès-verbaux résumant la décision de chaque membre du comité, rapports de politique monétaire semestriels et rapport écrit au gouvernement au cas où une fourchette de +/- 2% autour du niveau d'inflation cible serait violée pendant trois trimestres consécutifs. [19659002] Le MPC, âgé de deux ans, a tenté résolument de fixer son taux d’inflation de manière crédible, processus généralement reconnu et documenté de manière empirique pour réduire les rendements obligataires à long terme et stabiliser le taux de change. Bien que le jury reste un peu en dehors de l'impact économique du cadre flexible de ciblage de l'inflation, il est incontestable que le MPC a doté la politique monétaire d'un fondement institutionnel indépendant. Le gouvernement mérite beaucoup de mérite pour sa clairvoyance en légiférant les changements nécessaires pour renforcer cet aspect de l'indépendance de la banque centrale et en prenant ses distances par rapport au processus de décision monétaire (autre que par la nomination de membres externes au MPC). [19659002] (2) Gestion de la dette: pendant plusieurs décennies après l’indépendance, la Banque de réserve a participé aux émissions à court terme de bons du Trésor du gouvernement indien (portant des taux d’intérêt extrêmement bas) pour financer ses déficits publics. La Banque de réserve a également reconnu publiquement que ses opérations d'open market (OMO) visaient principalement à gérer les rendements des obligations d'État. Cela impliquait que le bilan de la banque centrale était toujours disponible, tout comme les recettes fiscales, prêt à monétiser les dépenses excessives du gouvernement. Sans surprise, l’inflation élevée en Inde a été conçue pour plaire à Milton Friedman et Thomas Sargent, c’est-à-dire qu’elle a toujours été un phénomène à la fois monétaire et fiscal, comme l’avaient respectivement soutenu ces deux lauréats du prix Nobel d’économie (Friedman, 1970 et Sargent, 1982).
En fin de compte, reconnaissant l'imprudence fiscale et les risques inflationnistes engendrés par cette monétisation automatique des déficits publics, les efforts conjoints de la Reserve Bank et du gouvernement au cours de l'exercice 1994-1997 ont limité le financement du déficit par la Reserve Bank aux avances plafonnées en termes de moyens et de moyens (WMA). ). La loi de 2003 sur la responsabilité budgétaire et la gestion budgétaire (FRBM) interdisait explicitement à la Banque de réserve de participer aux émissions principales de titres du gouvernement. Les opérations d'open market ont été conçues pour atténuer l'impact des interventions en devises sur la mbade monétaire nationale et / ou pour répondre aux besoins de liquidités durables de l'économie, plutôt que pour financer des déficits. Bien que certaines habitudes aient été remplacées, ces changements ont laissé globalement la tâche de la gestion de la dette publique à la Banque de réserve consistant principalement à mettre aux enchères la dette publique et à l'aider à pbader d'un titre à l'autre ou à effectuer des rachats, plutôt que de s'impliquer de manière complexe dans la planification budgétaire et, plus important encore, dans son financement.
En outre, les niveaux répressifs de Ratio Liquid Liquid (SLR) et de Cash Reserve Ratio (CRR) répressifs, qui garantissaient qu'une partie substantielle des dépôts bancaires était transférée au gouvernement ou était facilement disponible pour réduire en valeur par le biais de l’expansion monétaire, ont maintenant été rationalisées pour être plus ou moins conformes aux normes prudentielles internationales. Par exemple, dans le cas des reflex, le niveau a été progressivement réduit et il est prévu de l'harmoniser avec le ratio de liquidité à court terme de Bâle III.
(3) Gestion du taux de change: dans les plans quinquennaux post-indépendance , prices including the exchange rate were badumed to be constant; however, since the true value of the Rupee fluctuated with market prices and macroeconomic conditions, the Sterling holdings had no choice but to take an undue hit. The underlying true value of the Rupee was also affected heavily –– but not reflected in reality –– by monetary policy and debt management operations that were implicitly supporting the ballooning of government deficits. The result of the fixed exchange rate regime in the midst of “fiscal dominance” was that the Reserve Bank was essentially a silent spectator in the build-up to the inevitable exchange rate disequilibrium (though arguably this was true of much of the world at that time).
Since 1976, when the level of the Rupee moved to being a “managed float” against a basket of currencies, and especially since 1993, the exchange rate has gradually evolved from being entirely a fixed rate to being market-determined for all practical purposes. The Reserve Bank deploys reserves management and macro-prudential controls on foreign capital flows to manage excessively large movements. With a flexible inflation-targeting mandate for interest-rate policy and funding of fiscal deficit no longer the objective of monetary operations, the desired exchange rate management rests with the Reserve Bank.
Ongoing Challenges in Maintaining Independence of the Reserve Bank of India
Few important pockets of persistent weakness, however, remain in maintaining independence of the Reserve Bank. Some of these areas were also identified in the 2017 Financial Sector Assessment Programme (FSAP) of India by the International Monetary Fund (IMF) and the World Bank (WB) as ways to strengthen the independence of the Reserve Bank, an area in which the FSAP rates India as “materially non-compliant”.
(1) Regulation of Public Sector Banks: One important limitation is that the Reserve Bank is statutorily limited in undertaking the full scope of actions against public sector banks (PSBs) – such as badet divestiture, replacement of management and Board, license revocation, and resolution actions such as mergers or sales –– all of which it can and does deploy effectively in case of private banks. The significant implications of this limitation were highlighted in detail in Governor Patel’s speech in March 2018, Banking Regulatory Powers should be Ownership Neutral. To reiterate from the FSAP (Para 39 in Summing up Responsibilities, Objectives, Powers, Independence, and Accountabilities, the Basel Core Principles Detailed Assessment Report):
“Legislation should be amended to enable the RBI to extend all the powers currently exercised over private sector banks to PSBs; in particular, regarding Board member dismissals, mergers and license revocation. … It should also remove the option of an appeal to the government when the RBI revokes a license. If statutory changes are difficult, the RBI and the government should consider adopting a framework agreement whereby the government would acknowledge the RBI’s full operational authority and independence in supervision and regulation, as they did recently for monetary policy.”
(2) The Reserve Bank’s Balance-sheet Strength: Having adequate reserves to bear any losses that arise from central bank operations and having appropriate rules to allocate profits (including rules that govern the accumulation of capital and reserves) is considered an important part of central bank’s independence from the government (see, for example, Moser-Boehm, 2006). A thorny ongoing issue on this front has been that of the rules for surplus transfer from the Reserve Bank to the government (Cogencis, 2018, “Govt pegs RBI excess capital at 3.6 trln rupees, seeks it as surplus”), an issue that relates closely to the leading Argentine example in my introductory remarks. It has been covered deftly by Rakesh Mohan (2018) in the last of his three-part series of recent articles on the Reserve Bank, titled Protect the RBI’s balance-sheet; therein, he elucidates why a central bank needs a strong balance-sheet to perform its full range of critical functions for the economy. I quote his main points below:
“First, … The longer-term fiscal consequences would be the same if the government issued new securities today to fund the expenditure. [R]aiding the RBI’s capital creates no new government revenue on a net basis over time, and only provides an illusion of free money in the short term.”
“Second, … The use of such a transfer would erode whatever confidence that exists in the government’s intention to practice fiscal prudence.”
“Third, … In theory, a central bank can implement monetary policy appropriately with a wide range of capital levels, including levels below zero. In practice, the danger is that it may lose credibility with the financial markets and public at large, and may then be unable to attain its objective if it has substantial losses and is seen as having insufficient capital.
Are fears with regard to possible central bank losses illusory? According to the Bank for International Settlements (BIS), 43 out of 108 central banks reported losses for at least one year between 1984 and 2005.
It is also argued by some that the government can always recapitalise a central bank when necessary. This is certainly true in principle but is practically difficult when the government itself suffers from fiscal pressures and maintains a relatively high debt-GDP ratio, as is the case in India. What is also important is the erosion of central bank independence both in reality and perhaps, even more importantly, in optics. …
Once again, better sense has prevailed and the government has not raided the RBI’s balance sheet.”
(3) Regulatory Scope: A final issue is one of regulatory scope, the most recent case in point being the recommendation to bypbad the central bank’s powers over payment and settlement systems by appointing a separate payments regulator (also covered by Rakesh Mohan in his series, ibid). The Reserve Bank has published its dissent note against this recommendation on October 19, 2018.
Conclusion
Let me conclude with some notes of gratitude and dedication as well as some for further reflection.
Mr. Malegam has been a long-time adviser, friend and well-wisher of the Reserve Bank of India, as well as its former Board Member. He is someone I personally admire for his intellect, clarity of thinking and sagacity. I thank you, Mr. Malegam, for inviting me to deliver the A D Shroff Memorial Lecture for this year.
The Late Ardashir Darabshaw Shroff served as India’s non-official delegate in 1944 at the United Nations “Bretton Woods Conference” on post-war financial and monetary arrangements. One of his primary concerns was to seek a permanent seat on the executive board of the International Monetary Fund and the World Bank, which unfortunately did not materialise. To me, his most important contribution was the co-founding in 1954 of the Free Forum Enterprise think tank which through open dialogue presented a counterpoint to the socialist tendencies that were taking root in the country in the post-independence era government. Sucheta Dalal’s biography, A. D. Shroff – Titan of Finance and Free Enterprise (2000), notes that George Woods, one of the most popular presidents of the World Bank, said of him:
“Nobody could accuse A. D. Shroff of hiding his opinions and in the later years of his life, very rarely were those opinions fashionable in India. Yet few patriots did more than he [did] to make friends for the Indian nation and to build confidence in that nation among those throughout the world whose business it is to provide capital for sound investment opportunities.”
In all humility, to emulate A. D. Shroff’s freedom to criticize policy “actuated by the single motive of trying to promote the good of my country” (from his letter to Sir Osborne Smith, the first Governor of the Reserve Bank), I chose for today’s occasion the theme of the importance of independent regulatory institutions, and in particular, that of a central bank that is independent from an over-arching reach of the state. This theme is certainly one of great sensitivity but I contend it is of even greater importance to our economic prospects. I earnestly hope that I have done some justice to his immortal legacy to independent economic discourse and policy-making.
In the process, I have attempted to convince you that we have made good progress in earning the Reserve Bank’s independence, most notably in the monetary policy framework (changes wherein, along with the Insolvency and Bankruptcy Code and the Goods and Services Tax, were considered as crucial structural reforms by Moody’s in upgrading India’s sovereign rating eleven months back). To secure greater financial and macroeconomic stability, these efforts need to be extended to effective independence for the Reserve Bank in its regulatory and supervisory powers over public sector banks, its balance-sheet strength, and its regulatory scope. Such endeavor would be a true inclusive reform for the Indian economy’s future. Thankfully, it is only a matter of making the right choices, which I believe as a society we can with adequately thoughtful “what-if” badysis; I have sketched a scenario, which several parts of the world are presently witnessing, of great risk to nations from undermining the independence of their central banks.
In his excellent biography, Volcker: The Triumph of Persistence (2012), my former NYU Stern colleague, Bill Silber, describes in vivid detail how in the 1980s, the then Federal Reserve Governor Paul Volcker adopted a curmudgeonly approach to setting interest rates to target inflation. Besides resisting any and all pressure to keep rates low, which would have effectively allowed cheap funding – in the short term – of President Reagan’s expansionary deficit-based manifesto, Volcker engaged personally with the President to convey the perils of running high fiscal deficits right after double-digit inflation had just been tamed. In the end, Volcker won the day as wise counsel prevailed, deficits were reined in, and inflation tamed even further. I would argue that through Volcker’s tough stance on inflation and candour on risks from government’s fiscal plans, the institution of the Federal Reserve had in fact been President Reagan’s true friend.
As many parts of the world today await greater government respect for central bank independence, independent central bankers will remain undeterred. Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution; their wiser counterparts who invest in central bank independence will enjoy lower costs of borrowing, the love of international investors, and longer life spans.
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