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An Independent Federal RBI

An Independent Federal RBI Agathopian Dream? A VISWANATHAN The Economist, referring to James Meade


and evolving situations with the help of the statutory provision of the RBI Act,

An Independent Federal RBI

Banking Regulation Act (BRA) and For-

Agathopian Dream?


he Economist, referring to James Meade’s book Full Employment Regained? An Agathopian Dream, described it as “an attack on current economic orthodoxies” and explained the high-falutin word agathopian thus – “This is a word of Greek origin, meaning the doctrine of the good, rather than utopian, the impossibly perfect”. Anand G Chandavarkar in his article ‘Towards an Independent Federal Reserve Bank of India’ (EPW, August 27, 2005) weaves an agathopian dream around an institution which played a major role in financial sector reforms and never felt the need to reform itself, notwithstanding the references to the independence of RBI found in the speeches of some high functionaries. The article is in a way a frontal attack on orthodoxies in the theory and practice of central banking in India – a sort of Derridian deconstruction of the philosophy of central banking.

As Robert J Aumann observes, “while constructing a theory, we are not trying to get at the truth or even to approximate to it. Rather we are trying to organise our thoughts and observation in a useful manner”. In this article Chandavarkar is trying to organise his thoughts and observations on the subject in a useful manner and the resultant brilliant work is not only the signature of his scholarship, for which he is well known, but also becomes an agenda for a “political economy for reconstitution” and re-engineering of an institution which “alone remained inexplicably immune to reform and the global trend of legal independence and modernisation of central banks”.

While former governors of RBI have dealt with the theme of the independence of RBI, no one has dealt with the entire gamut of the subject in such depth and breadth. His article not only sets an agenda but also sets in motion debates and discussions on the theme from which may emerge the final architecture of a central bank shorn of its quasi-fiscal functions.

It calls one’s attention to the urgent need of reorganisation of the RBI.

Chandravarkar’s thesis centres on organisational change. It is useful to refer to the open system theory of organisation of Talcott Parsons and others which emphasises the need for the continuous flow of energic inputs, without which an organisation will soon suffer etiolation, and the necessary dependence of an organisation upon its environment. An understanding of organisational behaviour is, therefore, necessary when we deal with organisational reconstruction. For the first time the RBI is viewed from this angle. Chandavarkar uses the metaphor of the Hindu wife to describe the behavioural pattern of the RBI. What scholars call the J curve of conforming behaviour is the result of a statute put in place by a foreign government to subserve its imperial interests. The concept of an independent RBI presupposes drastic changes in the juridical environment by manipulating the legal system and structures. He plays a Hayden when he elaborates the future legal relation between the GoI and the RBI. It will not be substantively statutory but quintessentially contractual – echoes of Henry Maine who postulated years ago that the movement of progressive societies had been a movement from status to contract. Such schema assume the parity of the parties therein.

The RBI Act which informs the central bank and its functions, with all the amendments, remains anachronistic. A new statute in its place is to be passed if the required independence is to be achieved. If the new RBI is vested with only limited functions as the central monitary authority, a host of other statutes and new administering authorities have to be in situ to avoid the confusion and vacuum that may ensue following the withdrawal of RBI from certain fields. For instance, the Financial Services Act of the UK had to be passed to cope with the emerging situation. Even after two decades of its existence we do not have anything comparable to this. Presently the RBI copes with emerging eign Exchange Management Act (FEMA). Regulation of non-banking finance companies (NBFCs) will require creation of a new institution of the US model. In other words, to usher in the new order an entirely new legal regime is to be created and along with it, new institutional infrastructure. A complete dismantling of the RBI Act and its various provisions which give control to the government is thus a sine qua non of the proposed reform process.

Remodelling the RBI

The body politic of the new RBI with sufficient corporate sovereignty will have the independence to take decisions and implement policies and programmes. It will have a federal structure aimed at reflecting the federal features of the Indian polity. As Kingman Brewster Jr observes, “Political federalism may provide more metaphor than analogy to the problems and possibilities of handling corporate power. Certainly it does not offer a prescription”. On the contrary, in the present context, it is an analogy useful to explore the economic and non-economic dimensions of corporate power distribution. Gower in his Principles of Modern Company Law refers to the democratic features of corporate organs to explain the structure of companies. The idea of RBI, likewise, as a federal analogue of the Indian polity, has its own relevance. There are some thinkers who treat corporation as private government. This approach is closely connected to the Hobbesian concept that the corporation is a lesser common wealth. According to Earl Latham, “The corporation is a body politic which exhibits describable characteristics common to all bodies politic. The following five essential elements are present in a political system:

  • (i) an authoritative allocation of principal functions; (ii) a symobolic system for the ratification of collective decisions; (iii) an operating system of command; (iv) a system of rewards and punishments; and
  • (v) institution for enforcement of common rules.” These aspects have to be factored in while remodelling the new federal RBI. However, though there are valid reasons for a federal RBI, the suggestion of Chandavarkar to create regional level
  • Economic and Political Weekly January 14, 2006

    RBIs is fraught with risks of creating more confusion. Instead, the existing local boards can act as regional level RBIs, which can take care of the individual states’ interests more faithfully.

    The most important suggestion of Chandavarkar relates to drastic changes in the functional profile of RBI. The restructured RBI will be only administering monetary policy. This approach verges on the Friedmanesque, as it has all the trappings of what Eric Roll calls a “counter monetary revolution”. The controversy relating to fiscal policy versus monetary policy is likely to rear its head. RBI’s own publication refers to the subordinate position of monetary policy vis-a-vis fiscal policy. Chandavarkar admits that the monetary policy instrument is not a stand – alone one. An independent RBI necessarily means that it will maintain independence in policy matters. Chandavarkar refers to instrument independence. In the context of the very close integration of different markets it remains to be seen how effective the monetary policy can be in achieving its objectives. Eric Roll observes:

    It also illustrates to some degree certaindeep seated differences to the problems ofthe economy as a whole between “interventionists” and “expansionists” on the onehand as against “non-interventionists” and“deflationists” on the other hand, of which even though the major debate may now beclosing down some residue can still befound here and there in the differing attitudes of treasuries (and finance ministers)and central bankers to specific situations.

    Deena Khatkhate’s doctoral dissertation, which became a very popular textbook among the postgraduate students of the 1960s, showed a tilt towards the paramountcy of fiscal policy over monetary policy. Such views were part of the received body of the economic doctrines of the 1960s. Chandavarkar’s suggestions as to the new role of the RBI not only revives the controversy but also is suspect regarding the effectiveness of monetary policy to achieve its avowed objectives.

    Since Chandavarkar has dealt with complex issues – teleological, tectonic and tactical – any action in that direction requires that all the suggestions, as in regard to legislation, creation of new agencies, due to changes in the structure of RBI, etc, are to be subjected to serious studies by experts. But Chandavarkar himself counselled caution when he struck a note of warning – a caveat reformer. The articulate arrivistes of the academia are quite likely to come forward to avail themselves of this golden opportunity. In the mid-1990s when two nationalised banks were declared sick, an academic from a prestigious institute was commissioned to prepare a report on turnaround strategies. The learned professor’s recommendation was to liquidate the bank, instead of reviving it by further infusion of capital by the government, as the bank was beyond redemption. Both the RBI and the government fortunately did not take this recommendation very seriously. The same bank now is one of the profit-making ones!

    ‘Infallibility’ of RBI

    It is generally presumed especially by those in the bank that the RBI is infallible. However V V Bhat explodes this myth when he refers to the negative policy intervention by the RBI. Venkitaramanan, based on the studies of Prabhu Ghate strongly recommended integration of the informal sector with the mainstream financial system, rather than legislating out of existence this important sector through the amendment of Sec 45S of the RBI Act. When this amendment was challenged before the apex court, the RBI justified its position. Quoting an American judges’ “obiter dicta” the RBI claimed all the wisdom in matters of banking. RBI also put forward a very strange reason for the amendment – it became necessary as RBI did not have sufficient manpower to discharge its regulatory functions! Reformers should also be aware of the negativism in RBI’s policies and programmes. Official publications carried articles justifying the RBI’s action, i e, amendment of Chapter III-C of the RBI Act (Sec 45S). This highlights the need for independent research to examine the impact of its policies. What one observes is a megalomaniac attitude which often conceals the so called executive arbitrariness which in legal parlance is known as “Wednesbury unreasonableness”.

    The story of Krishna Menon suspecting two RBI officials cannot be apocryphal as it was related to Chandavarkar by Prasad himself. But it is difficult to believe that all the officials possessed the same spirit of patriotism. There are episodes which are not recorded in the official history of the RBI and which are not flattering. Excerpts from an interview given by K N Raj prove that Menon was not entirely wrong. K N Raj reminisces:

    In those days Deshmukh and his economicadvisor B R Shenoy were not on goodterms. Shenoy was the person who opposed the Second Plan. He opposed alltypes of deficit financing. Shenoy heldorthodox economic ideas and theories... He vehemently argued for the devaluation of the rupee. Deshmukh was not in favourof that. This was the cause of their discord. Shenoy had good relations with the IMF(Later he was appointed as the Fund’sAsian Representative with Bombay as hisheadquarters). Parleys between the Indiangovernment and the IMF started. One dayShenoy asked me to meet him. When I methim he enquired about the progress in thecompilation of BOP statistics (Shenoy waspreparing to join the IMF leaving the bank).I replied that there was considerableprogress. He wanted to peruse the compilation. I smelt a rat. So I did not giveit to Shenoy. Shenoy submitted his paperto the IMF suggesting devaluation of therupee on the basis of the data collectedfrom other divisions along with the copiesof office notes. The IMF started pressurisingthe government. On the basis of the Shenoypapers the Fund suggested devaluation ofthe rupee. They argued that the Indianeconomy was in a poor shape and recourseto devaluation was the only way out. Theycould array facts and figures compiled bythe RBI, excluding those relating to BOP tobuttress their arguments. The governmentwas in a quandary. So also Deshmukh. Hisonly comfort was that the IMF could notpresent the BOP data. Narayana Prasad calledme and showed me the IMF report. Whatnext? When I read the report I felt that arejoinder could be easily prepared. On thebasis of the BOP data I prepared the rejoinder to the IMFs report. The gravamenof my rejoinder was that there was nonecessity of devaluation and the Indianeconomy was basically sound. My replywas presented as the official communication by the government to the Fund.Deshmukh and Narayana Prasad were veryhappy (translated from Malayalam,Kalakaumudi, August 12, 1990).

    K N Raj was a research officer then. He stood between devaluation and the rupee like the Roman hero Horatius Cocles who stood between the city of Rome and the invading Etruscan army. You can draw your own conclusion from this episode.

    In conclusion, Chandavarkar has made very valuable suggestions. They have been made not a day too soon. One hopes the authorities concerned will wake up to his call. This suggestion about an independent federal RBI requires independent research into the various aspects of central banking. To Peter Drucker the strength of an organisation lies not merely in the efficiency of its operational activities. It has got a great deal to do with its “conscience activities”. The activities falling under this latter category undertaken by the RBI are only for justifying its policies and result in no value addition. Hence the need for independent research as a desideratum for reform.



    Economic and Political Weekly January 14, 2006

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