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Independent Federal Reserve Bank of India

Independent Federal Reserve Bank of India A Response to Comments ANAND CHANDAVARKAR Ihave the following reactions to the comments on my article (August 27,


Independent Federal Reserve Bank of India

A Response to Comments


have the following reactions to the comments on my article (August 27, 2005).

P Chattopadhyay (September 10, 2005) suggests that the “RBI should come under the purview of the Comptroller and Auditor General of India (CAG)...with matching accountability.” However, given the sui generis character of RBI accounts and audit and the lack of the requisite capability in the CAG, “a diminished institution” [Iyer 2005] unable to discharge efficiently even its existing duties and functions. However, Chattopadhyay is right on mark in his reference to the “directivities” suffered by India’s “important national institutions”, particularly the RBI, which has remained “subservient to the dictates of New Delhi”.

Meenakshi Tyagarajan (September 24, 2005) argues that my case for an independent RBI relies on “the advantage of hindsight”. My case is based on theory, which does not involve hindsight as well as on evidence, which is necessarily ex post. “It is hard to imagine where else can data come from but the past. So economics is about accounting for the past” [Solow 2005]. I am completely nonplussed by Tyagarajan’s statement: “what is essential for an effectively autonomous central bank is not so much alterations in the legal framework but a fundamental change in attitude”. The whole raison d’etre of statutory CBI is predicated on the need to depersonalise central bank-government relations so that the efficient discharge of central banking functions does not depend on the attitudes and whims of either finance ministers or governors, who can scarcely be expected to be composites of Aristotle and the Archangel Gabriel.

Tyagarajan’s plaudits for the developmental role of the RBI are strikingly at odds with the recommendation of the working group of the Administrative Reforms Commission set up to study the working of the RBI (1969) which described the RBI’s promotional and developmental responsibilities as a “historical accident”. The working group’s report argued that these “did not go well with its role as a Central Bank”. It was emphatic: “If as a Central Bank the R[eserve] B[ank of] I[ndia] is to discharge its main functions of management of money, development and regulation of banking and credit policies, and administration of exchange control, it should not be bothered with... developmental and promotional functions” this suggestion is a non-starter [Balachandran 1998]. It is one of the many mysteries of the working of the RBI that this eminently sensible recommendation was never implemented. Knowledge comes but wisdom lingers. At any rate the remaining vestiges of the RBI’s developmental role should be completely divested as part of a reform package. Whatever the historical justification for the development role of the RBI, it is no longer relevant today. There is an equally strong case for separating debt from monetary management as in US, UK, Australia, Mexico, New Zealand, Sweden et al [Singh 2005].

A Viswanathan in his scholarly and balanced comments (January 14, 2006) suggests that, rather than a full-fledged federal RBI, “the existing local boards can take care of the individual state’s interests more faithfully”. These opaque local boards are symbolic appendages to an essentially unitary RBI and cannot be regarded even as approximations to a genuinely federal RBI. In any event, it is unclear why monetary federalism should be regarded as “fraught with more risks and confusion” than the prevailing political and fiscal federalism.

Overtone of Ad HominemOvertone of Ad HominemOvertone of Ad HominemOvertone of Ad HominemOvertone of Ad Hominem

A Vasudevan (October 15, 2005) has purveyed a hectoring farrago of unsupported strictures with a high-decibel overtone of ad hominem that does not spare even Rama Rau and I G Patel. To begin with he makes the absurd charge that I have “not stated my own position clearly despite the fact that the word ‘independent’ occurs in the very title of his article”. I have emphatically stated “there is an overwhelming case for constitutional rather than statutory independence for the RBI... given the potential for political pressures and economic populism even under statutory independence with its scope for frequency of amendments...the case for CBI rests not so much on the achievement of specific economic objectives but on the insulation of monetary policy from partisan politics... The conceptual rationale of CBI derives from the accepted doctrine of the separation of powers and authorities in a democracy” (pp 3843-44). In his lengthy comment, totally bereft of any scholarly apparatus, he plays his signature tune that Chandavarkar has not given sufficient evidence for his statements. He even doubts whether my “citations are contextual”, and adds gratuitously that I “have chosen to ignore all the writings in financial dailies perhaps because the articles appearing in them are not refereed”. What is the relevance of press comments on RBI publications in a comment on RBI independence? For a professional economist Vasudevan has a mysterious allergy to refereed periodicals.

Laundry List of RBI ReformsLaundry List of RBI ReformsLaundry List of RBI ReformsLaundry List of RBI ReformsLaundry List of RBI Reforms

Vasudevan gives a laundry list of what he considers various RBI reforms (sic) to prove that the RBI has “not remained immune to critically acclaimed reforms”. Thus, he cites changes in accounting practices and policies, the adoption of prudential norms and new supervisory mechanisms, clearing and payments systems, auctioning of government securities and legal authority over non-bank financial institutions (NBFIs). These are not reforms but merely organisational improvements. They do not address the core issues of Reserve Bank

Economic and Political Weekly July 8-15, 2006 independence, and security of office for the governor. Vasudevan makes great play with the “enormous work [of the RBI] of extraordinary analytical depth and of operational relevance” without giving even a single example of such work. Can he cite any publications of RBI staff, after the late 1960s, in the refereed journals to support his claim? If the RBI has done such an extraordinary work, why did it not publish the authoritative evaluation report on its research activities prepared by Srinivasan (Yale) and Raghuram Rajan (Chicago)? The learned professors have doubtless commented on “what the RBI does going by its (web site) is of the variety: This equation has been estimated with US data, let me do it with Indian data” [Sen 2006]. Sen, a recognised macroeconomist with several contributions in reputed refereed periodicals, such as Economica and Oxford Economic Papers, has struck the right note as follows:

Time was when India did not have a macroeconomic tradition. But today there are a large number of Indians (in the age group 30 to 40) in various foreign universities with good PhDs in that field. But to seek their opinion would involve acknowledging that they know more than the top dogs of North Block or the RBI. And that to the Indian bureaucracy is a fate worse than death.

Vasudevan further argues, like Oliver Twist always asking for more, that I should have provided far more material and legal evidence for my statement that the RBI can constitute an executive monetary policy committee without amending the RBI Act. I have clearly cited that the source for this statement is the RBI advisory Group’s Report (2004, Table 2) which doubtless has been cleared by the legal division of the RBI.

Vasudevan has completely misrepresented my invocation of Keynes’ criterion of practical financial and banking experience as essential for prospective central bank governors. This does not rule out academic economists who have also had relevant practical experience. For instance, Greenspan before he became the chairman of the Federal Reserve was president of Townsend-Greenspan (1958-74, 1977-87); director of Trans-World Financial Co, Dreyfus Fund, JP Morgan and Co; chairman, Council of Economic Advisors 1974-77. Likewise, Mervyn King was the co-director, LSE Financial Markets Group (1987-91) and deputy governor (19982003) before he became the governor of the Bank of England. The financial and market experience is far more useful in crises management and problem-solving than academic expertise which can always be provided by an economic advisor and an efficient research department. The overwhelming majority of successful central bank heads have been practical financiers like the legendary Montagu Norman (Bank of England) and Benjamin Strong (Federal Reserve). One chairman of the Federal Reserve, William Miller (1978-79) was an engineer, a lawyer and a corporate executive. As the late Sir Maurice Parsons, former deputy governor of the Bank of England, remarked perceptively: the true hallmark of a central banker is “How well does he know his markets”. I never said, as alleged by Vasudevan, that only “bankers have the public good at heart” and “not academics and technocrats”. In any event, the public good or the social welfare function is properly defined by the legislature in a democracy and not by bankers, academics and technocrats. On top of this is yet another

Economic and Political Weekly July 8-15, 2006

brickbat for me: I “live in the world of make-believe”.

Vasudevan would do well to recall the performance of Schumpeter, who was rated the most disastrous finance minister (1919) in Austria, where he, as the president of the Biedernan Bank also sent it into premature bankruptcy. No wonder Hayek was never tired of reminding his London School of Economics (LSE) students that interwar Austria had the best economists and the worst inflation. Vasudevan might want to test a similar correlation between best economists and the Hindu rate of growth in India. Economics may well be the imperial social science, but economists can scarcely behave like unconstitutional emperors.

Misrepresentation of FactsMisrepresentation of FactsMisrepresentation of FactsMisrepresentation of FactsMisrepresentation of Facts

Vasudevan’s version of governor Rama Rau’s resignation is a grotesque travesty of facts on the part of one who claims to “have dabbled with the history of the RBI” as these facts are fully documented in the RBI history. He utterly trivialises it as a case of bad chemistry between Rau and the finance minister T T Krishnamachari, and maintains that “Rama Rau’s conduct was outside the realms of protocol and decent operational procedures”. Rama Rau, in fact, was fully within his rights to protest against the levy (without consulting the RBI), of variable stamp duties on bills which would increase the cost of credit and undermine the bill market scheme and erode the bank rate mechanism. All matters squarely within the RBI’s mandate. In fact, Rama Rau would have been guilty of dereliction of duty if he had not protested in the most constitutional way to Nehru against the grossly intemperate behaviour and language of TTK. Rama Rau’s letter to Nehru is a sober and cogent statement of the issues concerned and the reasons for his resignation [Balachandran 1998]. In his letter of resignation to TTK, Rama Rau said “I have more than once protested against your personal rudeness in the past, but I was prevailed upon to overlook it...however, because of the public attacks on the Reserve Bank...I submit my resignation” (ibid:1164). The RBI historian rightly concluded “It was...entirely appropriate that Rama Rau should have sacrificed his office in defence of the Bank’s independence (emphasis provided) (ibid:724). Significantly, the history also notes that TTK “had for years held an unflattering opinion of Rau” and that Krishnamachari “had confessed that he was prejudiced against Rama Rau and had criticised his appointment in the past” (ibid:714). Who then was guilty of not observing protocol procedures and manners, Rama Rau or TTK?

To his lasting credit Rama Rau in his dignified and modest retirement did not make even an oblique reference in public or private to his resignation. As he told an American academic and a former RBI staffer, Sid Mitra: “Young man, the secret will die with me”. In his Alladi Krishnaswamy Aiyer Lectures (1960) to the Madras University on central banking in India, he never referred to his resignation. It does not reflect too well on the RBI that it did not publish his obituary in its Bulletin, a courtesy extended even to deputy governors. The only obituary of Rama Rau was the glowing tribute of the Council of King’s College Cambridge, his alma mater, in its Annual Report, November 1971. It said:

Sir Rama Rau was a man of outstandingly high standards...his abilities, his tact, and his political leanings, were responsible for his being chosen as secretary to the Indian Delegation in London from 1931 to 1934 (Round Table Conference)...Rama Rau made no concealment of the fact that – though a devoted government servant – he nevertheless felt sympathy with the general aims of the Indian nationalist movement.

Bizarre ObservationBizarre ObservationBizarre ObservationBizarre ObservationBizarre Observation

In his desperate endeavour to criticise Rama Rau, Vasudevan has even made the bizarre observation that he was “obliged to Deshmukh for becoming RBI governor”. What is his evidence for this? He is clearly unaware of Rama Rau’s background and pre-RBI career. Rama Rau was a brilliant Cambridge graduate in mathematics who was very much senior to Deshmukh in the ICS. He rose rapidly to become a secretary to the Indian delegation and advisor to the Round Table Conference, where he was actively involved, among other projects, in the discussions relating to the creation of a Reserve Bank of India. I recall too as a lecturer in Siddharth College (mid-1946) the glowing tribute of Ambedkar to Rama Rau for his amazing grasp of constitutional law, public finance, central banking, and even the daunting mechanics of documentation and conferencing which were of invaluable help to him, particularly and generally, to all Indian delegates to the Round Table Conference. After independence he proved a very successful ambassador to Japan and US. Interestingly, during his stint in Washington he personally studied the bank inspection procedures of the Federal Reserve which he put to good use in his tenure as RBI governor, an appointment which was largely the initiative of Nehru. Vasudevan has been misled by the fact that Rama Rau had the humility and good sense to understudy Deshmukh for three months before assuming charge as governor because he was new to central banking, whereas he had adequate experience of government finance as an under-secretary in the Madras government and later as the secretary of the Todhunter Committee on Indian taxation.

Remarkably, Rama Rau’s tenure as governor (who was not an economist) was the most creative in the history of the RBI. He initiated systematic and periodic inspection of commercial banks although it was not a statutory obligation under the Banking Companies Act, 1949, and was responsible for the bill market scheme, rural credit survey, integration of commercial banks, creation of the department of banking development, Bankers Training College, Shroff Committee on Industrial Finance et al. Vasudevan does not tell us what the achievements of Krishnamachari were, apart from his being the only finance minister of India since 1857 who had to quit after a judicial enquiry and dismissal by the prime minister. Krishnamachari scarcely belonged to the distinguished line of finance members/ministers of the government of India from 1857 – James Wilson, Basil Blackett, George Schuster, James Grigg, Jeremy Raisman, Shanmukham Chetty, John Mathai and C D Deshmukh.

In a comment ostentatiously dedicated to the memory of I G Patel, Vasudevan has thought it fit to characterise Patel’s unequivocal statement that there is no justification “for the [RBI] to be as subservient as it is today” as “a momentary slip from his customary caution”. Patel was the most circumspect of beings: one who was known to weigh and measure every word and sentence he spoke or wrote. This statement was made in his memoirs which are the mature and definitive embodiment of his views on all major policy issues. What evidence does Vasudevan have to substantiate such an egregious misinterpretation of a civil servant of the highest integrity who never fitted into Timur Kuran’s

Economic and Political Weekly July 8-15, 2006


Economic and Political Weekly July 8-15, 2006

dichotomy of economists with private truths who express public lies? K S Krishnaswamy, a former deputy governor who also served in the government of India, rightly remarks in his sensitive obituary of Patel: “as governor, he (Patel) could not always call the shots. New Delhi made a point of reminding him who was boss!” (EPW, August 6, 2005). To his credit, Krishnaswamy was also the first economist and senior executive of the RBI to sound the tocsin in the public domain of the subservience of the RBI in a memorable but hardly remembered article, ‘The Reserve Bank of India and Government’ [Krishnaswamy 1985]. He remarked trenchantly that “the Emergency settled once for all the issue [the RBI’s status and authority] in favour of the government by force majeure”. Would Vasudevan also accuse Krishnaswamy and the editor of Commerce of “a momentary slip from customary caution”?

Vasudevan says I have “opened a can without realising the dangers of [my] recommendation” (for a federal RBI), but does not specify what are the worms he has seen or smelt in that can. Why is monetary federalism alone pernicious in a political and fiscal federation? This is so typical of his stance throughout his comment. He does not feel obliged to furnish even an iota of evidence in support of his assertions.

Evaluation of RBIEvaluation of RBIEvaluation of RBIEvaluation of RBIEvaluation of RBI

Vasudevan is “most concerned about Chandavarkar’s suggestion for appointment of a high-powered non-official RBI Commission” and adds “he would have to come out with much more evidence than what was provided in the article”. Once again, he does not indicate what additional evidence should have been provided in an article which is fully supported by the state-of-the-art in economics and political economy. He labels my suggestion for inclusion of non-national members, if necessary, as naïve. Such a provision would provide for expertise not available in India. Does India have any draftsmen of central bank statutes of the calibre of Robert Effros, formerly of the IMF, who has crafted and revised several central bank statutes for member countries, or macroeconomists of the calibre of Sushil Wadhwani (LSE) who, apart from his well known theoretical contributions, has served with distinction as a highly independent member of the Bank of England’s Monetary Policy Committee, and has proved himself a very successful investment banker.

My proposal for evaluation of RBI was, of course, related to evaluation after the creation of a statutorily independent RBI. The provision for evaluation by a nonnational as in the case of New Zealand (Larsen, a Swedish national) and Bank of England (Donald Kohn of the Federal Reserve) would be particularly relevant for India where even the suitable experts understandably hesitate for fear of offending the establishment. The price for dissent in India can be heavy. Is Vasudevan aware of the persecution of B R Shenoy for his free enterprise views after his resignation from the RBI? Does Vasudevan know that Nehru the “peerless democrat” (sic) had even contemplated confiscation of Shenoy’s passport for fear that he might criticise India’s pseudo-Fabian post office socialism and propagate the free market gospel in international fora? Of course, Nehru’s ‘chelas’ have all joined the free market ‘ratha yatra’ after 1991.

As a parting shot, Vasudevan insinuates that I have lapped up the statement that “Indians are argumentative without questioning” while overlooking “Indian democratic traditions”. In fact, my whole case for an independent RBI is based firmly on the ground that it is critical for closing India’s democratic deficit. All contemporary democracies, including Poland, an excommunist state, have independent central banks, except the largest democracy – India. The final accusation is that I have attempted to “throw the baby out of the bathwater merely for the sake of some indefinable independence (emphasis mine). On the contrary, I have drawn up an agenda to enable the RBI baby to grow up into a responsible and effective constitutionally independent adult central bank in a functioning democracy, and not remain an eternal Peter Pan, wallowing in 70-year old stale bath water.

Alas, for Vasudevan the whole world is out of step, except for himself: the boorish Rama Rau was ignorant of manners, protocol, and decent operational procedures; Patel was a loose canon, who did not mean what he said or wrote: Balachandran cannot write history; and the “naïve” and clueless Chandavarkar, who cannot even define central bank independence, has the gumption to argue for an independent federal RBI. Truly, greatness has been thrust upon me that I should find myself in the distinguished

company of two RBI governors and the

RBI historian. Be that as it may. At least

one reader hugely enjoyed a rich smorgas

bord of omniscient pontification, suppres

sio veri, suggestio falsi, and ipse dixit

raised to an art form. In addition Charles Goodhart (London

School of Economics) wrote in an email

to me (December 5, 2005):

I greatly enjoyed reading your well-argued and well-written paper advocating independence for the RBI, especially the historical anecdotes…I agreed with most of it with one exception. This was that you did not want a specific inflation target, to be agreed with the government, but rather a set of fuzzy “non-hierarchical” objectives. Apart from the belief that there is a vertical Phillips curve, so that, in the medium, and longer, run RBI cannot influence growth and/or employment – and so should not commit to aim to do so – there is a very strong politico-economic reason for getting the government to participate in publicly setting the inflation target. The reason is that it makes the choice of goal their responsibility, makes the CB a technical (not a political) body, and prevents the politicians in government from criticising the CB – a public dispute which is currently disfiguring the operation of monetary policy in the Euro-zone. Goodhart’s argument in support of specific inflation targeting as the prime objective for the RBI further buttresses the case for a constitutionally independent RBI. “The complementarity of price stability with the other goals of monetary policy is now the consensus view among economists and central bankers” (Bernard Bernanke, in his first speech as the chairman of the Federal Reserve, Financial Times, February 25-26, 2006, p 5). Clearly it is time for the RBI to say, paraphrasing Carlos Diaz-Alejandro’s ‘Good-bye Phillips Curve. Hello Inflation Targeting’ without fear that the Phillips curve might be reincarnated in a new avatar in the land of karma.




Balachandran, G (1998): The Reserve Bank of India, 1951-1967, p 701.

Iyer, Ramaswamy R (2005): EPW, December 31.

Krishnaswamy, K S (1985): Commerce, Bombay, September 7, p 35.

Sen, Partha (2006): EPW, January 14, p 100.

Singh, Charan (2005): Working Paper, No 240, February, Stanford University.

Solow, Robert (2005): Daedalus, Fall, p 96.

Economic and Political Weekly July 8-15, 2006

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