Do not destabilise Reserve Bank of India

The FSLRC, in a hurry to resolve certain minor issues, ignored the evolution of the role and the care with which the RBI has nurtured the financial sector

Dr Raghuram Rajam, the governor of Reserve Bank of India (RBI) in a speech in Mumbai on 17 June 2014, once again brought to the fore the need for equipping regulatory and supervisory institutions in the financial sector, to do their job better. The occasion was the First State Bank ‘Banking and Economic Conclave’ held at Mumbai, where he spoke on the theme “Financial Sector Legislative Reforms Committee Report (FSLRC): What to do and when?” In his relatively short speech, Dr Rajan spoke in some detail about a variety of aspects covered in the report of the Financial Sector Legislative Reforms Commission, which was Chaired by Justice (Retd) BN Srikrishna.

It is quite possible that the RBI Governor’s observations about FSLRC recommendations may get lost in the criticism surrounding the timing of comments, and the seriousness with which they have been made could get diluted in the process. But, for those who have been following the positions taken by some of the members of FSLRC and by the RBI top management, the concerns expressed by Dr Rajan do not come as a surprise. Rather, they must feel relieved that there is strong leadership in the financial sector, that can defend the stand consistently taken by the central bank.

The Hindu carried the following report on 28 June 2014:

Former Union Minister and BJP leader Subramanian Swamy has asked Prime Minister Narendra Modi to replace RBI Governor Raghuram Rajan for his “wrong policies”.


In a letter to the Prime Minister, Dr Swamy has enclosed a copy of a letter from former Supreme Court judge Justice BN Srikrishna, which he says is an indictment of the RBI governor for his wrong policies.


He also pointed out that it sends a wrong message about the NDA government that persons like Dr. Rajan would continue to be Governor of the RBI on the grounds that he is qualified, as if “there are no patriotic Indians who are equally or more qualified than him”.


I had hoped that upon our Government taking office... [Rajan] would be replaced and in his place someone more highly qualified and patriotic such as Dr. R Vaidhyanathan, Professor of Finance, Indian Institute of Management, Bangalore, would be appointed,” the letter says.


The contents of the letter from Justice BN Srikrishna forwarded to the Prime Minister have not been revealed. Quite possibly, they may be on the lines of the short article, ‘indicting’ Dr Rajan, co-authored by Srikrishna and D Swarup and published in the Economic Times last week.

Though any citizen can have a view on who should be the RBI Governor, and the decision on who should hold that post is taken following certain processes and procedures, the issue having been raised by someone who can keep controversies alive longer than their normal ‘life span’, let us go a little deeper into the background of the demand made by Dr Subrahmanyam Swamy.


Not much research is needed to conclude that the Finance Ministry and FSLRC, in a hurry to resolve certain minor issues, ignored the evolution of the role of RBI and the care with which RBI has nurtured the financial sector. The Federal Reserve (in the US) and RBI function in two different worlds. To say that the time is not right for dismantling or truncating the RBI, which is doing creditably well as has been admitted in several international forums, would be stating the obvious.


The dissenting notes recorded by four out of seven members who signed the final report are well-argued documents, which inter alia plead the case for maintaining the basic features of RBI and assert the need for allowing the central bank to carry on with its present mandates. One wonders what motivated the FSLRC Chairman to finalize the report ignoring the difference of views expressed especially by KJ Udeshi, PJ Nayak and YH Malegam.


It would appear that the Commission did not get an opportunity to understand the present relationship between the RBI and Government of India (GoI). The regulatory apparatus plus legislations in financial sector in India are in good working condition. It has to be admitted that till Dr Rajan’s emergence as an acceptable leader of the Indian financial sector, the FSLRC’s effort to re-invent the institutional structure of regulatory bodies had pushed the regulators and supervisors, with the exception of RBI, into a confused state, making the possibility of an intelligent debate on the issue remote.


The idea of creating a Unified Financial Agency (UFA) for all financial regulators except RBI, truncating RBI by separating public debt management functions and housing the agency doing that work (presumably with the same work force) in RBI premises, then having the UFA subsume the truncated RBI, all give a feeling that the FSLRC was not allowed to ‘apply its intelligent mind’; and in the eagerness to satisfy all, it had forgotten its original brief. Perhaps, the purpose would be served better, if RBI is allowed to function with its present mandate and a coordination committee sorts out issues among the remaining regulators. If GoI's aim is to reduce the number of regulators, after necessary groundwork, merger of the regulatory agencies outside RBI one by one once the work stabilizes could be thought of. The twin goals of one Unified Financial Agency and managing the man-power-related issues that may arise with merger could be better handled this way.


In my article on Dr Raghuram Rajan published in The Global Analyst (September 2013), I had quoted the following excerpt from a mail I received soon after the appointment of Dr Rajan as RBI Governor was announced:

“Raghuram Rajan is well known for his independent views and he was one of the economists who had predicted the Global Financial Crisis. During the farewell function for Alan Greenspan in 2005, Rajan delivered a controversial paper with the title “Has Financial Development Made the World Riskier?"


Rajan predicted the Global Financial Crisis. He argued that financial sector managers were encouraged to take risks (called tail risks) that generate severe adverse consequences with small probabilities, but in return offer generous compensation rest of the time. He further argued that the most important concern is whether banks will be able to provide liquidity to financial markets This is exactly what happened.


The US Treasury Secretary, Lawrence Summers ( known for his arrogance), was on the dais and he accused Rajan of being a “luddite” (a 19th century expression for being a violent protester, especially one who is opposed to progress). Rajan's misgivings were eventually proved right. Rajan also has clear positions on austerity measures and he has been at loggerheads with the liberal Princeton economist Paul Krugman (A Nobel laureate).” I recount all this in the context of the biting criticism Dr Rajan is being subjected to for his way of expressing his views. The FSLRC report has not so far been subjected to serious study, for taking up its recommendation for implementation. It has generated more problems than it has tried to find solutions.


The first ever serious indictment of the Financial Sector Legislative Reforms Commission came in SS Tarapore’s article ‘A Plot to Destroy RBI’ published in The Hindu Business Line on 3 May 2013. The article concluded with the following observations: “Devil in the detail: The Commission recommends the setting up of a statutory Monetary Policy Committee (MPC) to take executive decisions on monetary policy with each member having a vote and the Chairperson having a veto, which must be explained with a public statement. The devil is in the detail. There would be only two RBI members and five external members appointed by the Government. The Ministry of Finance nominee would be a non-voting member on the MPC but would articulate the Government viewpoint. With Big Brother watching over their shoulder, brave would be the external member who would deviate from the Government line. The RBI would be better off with the present arrangement. The leitmotif of the FSLRC is to charge the gate of the temple of money with iconoclastic fervour. One prays that in this internecine battle, the RBI’s Pretorian Guards fight off the charge of the Commissioners. One must remember that countries that destroy their central banks destroy themselves.”


The article “Why Rajan is Wrong”(26th June) co-authored by Justice BN Srikrishna, and D Swarup, Member-Secretary of the FSLRC, attempted to presume and conclude that the RBI Governor was wrong in expressing his views against FSLRC's recommendation to super-impose a ‘Tribunal’ over RBI.


Dr Rajan had focused only on the aspects concerning RBI and the article has used SEBI experiences and sanctity of ‘rule of law’ to conclude that ‘Rajan is wrong’. While on the defensive, there is no harm in drawing arguments from anywhere, but it would have appeared more convincing, if some instances were shown where RBI would have performed better, had the proposed changes been in place.


The article states that ‘We reject Rajan’s claim that the regulator must continue to have discretionary powers and should not be answerable’. Does this ‘rejection’ go well in the context of Dr Rajan’s following observation? “Am I arguing that no checks and balances are needed? Certainly not! But there are already checks and balances in place, including review by constitutional courts like high courts through writ petitions. Senior officers of the regulator are appointed, and can be removed, by the government. The FSLRC recommends an annual report to parliament, as well as regular discussions with parliamentarians. These are good suggestions, which would add to oversight.”


It may be recalled that the FSLRC report, which was signed by seven members, had dissenting notes from K J Udeshi, P J Nayak and Y H Malegam (all members). In effect other than the chairman and the Member-Secretary, only two members were in agreement with the FSLRC report in its entirety.


It is unfortunate that the RBI and its Governor are being dragged into controversies on policy issues, which are debatable, instead of initiating healthy discussions on the anxieties expressed by those who are responsible for policy formulation and implementation.


(MG Warrier is a former General Manager of the Reserve Bank of India)

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