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Reflections on RBI-Government relationship

Summary:
Anantha Nageswaran wrote on the evergreen topic of RBI-Govt relationship which has again become interesting  following back to back book launches by Urjit Patel and Viral Acharya. An anonymous commentator responded to Anantha’s post which are contradictory to what most would think: The major difference between the RBI of last 10 years and the one from 1990-2008 was that outsiders began coming in the latter period (starting from Dr. Gokarn). These people did not have an understanding of the symbiotic relationship between government and RBI, especially in the wake of the hubris of navigating the 2008 crisis without much damage. Coming closer to the last six years, like you, I was very welcoming of the inflation targeting framework in 2014 and firmly believed that solving inflation was

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Anantha Nageswaran wrote on the evergreen topic of RBI-Govt relationship which has again become interesting  following back to back book launches by Urjit Patel and Viral Acharya.

An anonymous commentator responded to Anantha’s post which are contradictory to what most would think:

The major difference between the RBI of last 10 years and the one from 1990-2008 was that outsiders began coming in the latter period (starting from Dr. Gokarn). These people did not have an understanding of the symbiotic relationship between government and RBI, especially in the wake of the hubris of navigating the 2008 crisis without much damage.

Coming closer to the last six years, like you, I was very welcoming of the inflation targeting framework in 2014 and firmly believed that solving inflation was the number one priority. But, there was almost a religious zeal across the economist community back then even when fiscal policies were being run tight and we never course-corrected monetary policy from that.

The biggest error in judgement, I think, came from this idea that the media and RBI’s external leadership could coerce a popular government into submission by making public pronouncements. It probably did more damage to RBI than to the individuals, who made it all about themselves. Hence rather than shielding the institution, they went about making martyrs of themselves, whether it was Dr. Rajan or Dr. Patel or Dr. Acharya.

If one goes back and looks at their pronouncements on inflation, growth and fiscal, nothing fundamentally has worked out in the way they pronounced, largely because of policies partly run by RBI in terms of shrinking its balance sheet in % of GDP terms by almost 4 pp (from 24% of GDP in 2013 to less than 20% by end-2018), despite RBI’s foreign reserves growing by almost 50% and the currency depreciating as well. This coupled with fiscal policy being largely contractionary (at least till late 2017) turned out to be a double whammy for the economy. 2018 was a slight exception largely given an external wind which positively affected India and partly on account of a relatively low base too. However, by and large, RBI’s policy actions during that period compounded issues, despite low income growth and low credit creation. In sum, the monetary policy committee systematically over-predicted inflation, kept policy tight and dragged economic activity down.

 As you very pertinently note, the erroneous GDP data has done tremendous damage to India as well, much more than we realise. Yet, RBI, even as it cast aspersion on the accuracy of the data (RBI thought that GDP growth was being overestimated under the new methodology), chose to ignore the high frequency indicators which were signalling more modest growth and set policy purely on inflation, in a puritanical or perverse (or both) manner, shifting goalposts as it saw fit to run tight monetary policies (remember the debate on WPI vs CPI between Dr. Arvind Subramanian and RBI).

One area which you alluded to but not delved into completely, I thought, was the problem of material leverage in the NBFC sector, which was a direct consequence of demonetisation and excess liquidity in banking system that followed. It was completely done under the watch of Dr. Patel and Dr. Acharya. Payments banks and lack of follow-through on Dr. P.J. Nayak Committee report were other major failures. Most of these things were troublesome and required patient diplomacy with the government to push them through on part of the RBI, rather than making throwaway public comments. This “us vs them” mentality escalated into multiple conflicts – whether on the infamous February circular or with respect to board nominees – culminating ultimately in the resignation of several outside leaders.

While I sympathise with the individual thoughts of these excellent economists and thinkers, looking back, I realise that the system is not beholden to them and this idea that an individual’s departure would trigger runs on currency or money markets – like many, I was guilty of thinking  that when Dr. Rajan left – has been conclusively disproved. In fact, I would argue that Shaktikanta Das has been gracious, cooperative and patient in understanding issues in the system and has gone about mitigating several open threads left for him to solve. The jury is still out on him but, in my personal view, he is doing quite well.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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