Did the finance ministry put pressure on RBI to present a glowing picture of the Indian economy in the high crisis years between 2011 and 2014? The relationship between the central bank and the ministry has once again come under focus in a new book by former RBI Governor D. Subbarao titled Just A Mercenary?: Notes from My Life and Career.
Subbarao has complained of pressure being put on him by the finance ministry, especially the then finance ministers Pranab Mukherjee and P. Chidambaram. I believe the presentation is one-sided and does not present the full picture.
First, a little factual correction. He has written, and I quote, “I remember one such occasion when Pranab Mukherjee was the finance minister. Arvind Mayaram, the finance secretary, and Kaushik Basu, the chief economic adviser, contested our estimates with their assumptions and estimates, which I thought was par for the course.” I did not work with either Pranab Mukherjee or Kaushik Basu in the finance ministry. The discussion must have been in the presence of my predecessor, though my tenure as the finance secretary did overlap with his as the governor. But this is a minor detail.
Also read: India doesn’t need new taxes to uplift its poor. Existing welfare schemes are doing well
RBI failed in heavy lifting
The fundamental question is: Aren’t the central banks expected to work with the finance ministries to deal with economic crises, such as the kind faced by the world in 2008? Or the extreme distress experienced by the Indian economy during the 2011-14 period? RBI failed to help with the heavy lifting when the country needed it the most. I can count several instances to prove my point, but let me restrict myself to a few.
Laurence H Meyer, Member of the Board of Governors of the US Federal Reserve System has stated that central banks typically operate under one of two types of mandate. A hierarchical mandate makes price stability the primary objective for monetary policy and subordinates other potential objectives. A dual mandate recognises both price stability and full employment as objectives and puts them on an equal footing. The US Fed follows the dual mandate.
It wasn’t a whim when the finance ministry asked the RBI to find a balance between growth and price stability under PM Manmohan Singh’s government. As the finance secretary during this phase, what was my remit? In 2011-12, the economy had tanked to 5.1 per cent, the fiscal deficit and Current Account Deficit were out of control, and India faced an imminent sovereign downgrade to junk status. Quick and effective policy interventions, both conventional and unconventional, were necessary. Shocking the economy back to a growth path required decisive action on the fiscal side and restoring the market’s confidence was crucial to give us some elbow room for policy action.
In our view, this required the RBI to support the government’s efforts. The least they could have done was not to further depress the sentiment with doomsday prophecies. The discussion was not to doctor growth numbers (the finance ministry did not interfere with data management as would be borne out by the then fiercely independent chief statistician of India) but to make a token moderation in the policy rates, or at the least, temper forward guidance in the governor’s policy announcements to ease the negative pressures. RBI was adamant and decided the expression of autonomy lay in doing neither. Have RBI’s forward estimates always been right? Most often, RBI revises its estimates several times during any financial year.
We at the finance ministry were as worried about inflation as the RBI. Having established the fiscal consolidation roadmap based on the Kelkar committee report, the government desperately needed support in signalling a fair balance between growth and price stability. RBI was not willing to relent. The governor stated in several meetings that he needed to see more evidence about how the government would achieve these targets. What evidence could we provide in the middle of the financial year? As it is, we did not only achieve the consolidation targets but bettered them in 2012-13 and 2013-14. The government resorted to yearly expenditure cuts of around Rs1 lakh crore to ensure the fiscal deficit targets were not breached.
Was the RBI right to be blindsided in favour of continuously raising policy rates? The RBI’s telescopic action of continuously raising interest rates had no bearing on inflation. By April 2010, the RBI had raised the effective policy rate from 3.5 per cent only 18 months ago, to 8.5 per cent, with no visible impact. However, it did batter the growth rates.
Also read: D Subbarao’s advice to Raghuram Rajan—concentrate on lunch menus not interest rates
Taper tantrums had the Rupee spiralling
RBI was equally adamant in not considering unconventional measures to stop the run on the rupee, which was exacerbated by its own miscalculation of the impact of limiting outward remittances. “Taper tantrums” had the Rupee spiralling down from Rs59 to a dollar to over Rs68 to a dollar. There was a panic in the market, and with predictions of 100 to 1, punters in the non-deliverable forward markets were having a field day.
Unless we reversed the forex outflow, there was no way we could salvage the Rupee. The RBI put its foot down when we suggested that large quasi-government rupee bonds should be issued in the global markets to raise $5-10 billion. The dollar-denominated RBI bonds were issued only after Subbarao demitted office and Raghuram Rajan took over as the Governor. In all, about $35 billion was raised by these measures, improving the market sentiments and moderating the forward trading in the rupee. We could pull back the Rupee to 59 a dollar by the end of FY2013.
It is difficult to understand how Subbarao, who had earlier been India’s finance secretary, expected that the RBI would not be asked to play a critical role in crisis management and that the finance ministry would not constantly make demands on his attention. While we all lived through tremendous pressures during that unprecedented crisis, did the finance ministry take any action that would have overridden the Governor’s authority using its extraordinary powers under the RBI Act? The answer is a firm NO.
The author is a former finance secretary to the Government of India. Views are personal.
(Edited by Anurag Chaubey)