Reserve Bank's Policy Perceptions: The Global ANALYST article
The Global ANALYST, May 2018
Reserve Bank’s Policy Perceptions*
M G Warrier
“…….When interest rates and prices in general are set free, when real and financial markets are freed internally and interlinked globally, when the public sector will have to compete in a free market for the resources it requires, when, in fact, the economy acquires all the complexity and at least some of the sophistication of the richer countries, will we be still able to maintain the old baggage of a Quantity Theoretic frame of mind? Should inflation be the only area of concern in fiscal and monetary policy or should we also have to deal on occasion with unduly low investment and employment and untenable interest or exchange rates? Should we not then be familiar with the very great advances made in monetary economics in recent years both in theory and in ferreting out stable and meaningful relationships among a variety of strategic variables?......”
-I G Patel
(November 1993 in his Foreword to ‘Monetary Economics for India’ by Dr Narendra Jadhav)
The First Bi-monthly Monetary Policy Statement, 2018-19 Resolution of the Monetary Policy Committee (MPC) Reserve Bank of India opened with a routine-looking statement:
“On the basis of an assessment of the current and evolving macroeconomic situation at its meeting today, the Monetary Policy Committee (MPC) decided to:
• keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.0 percent.
Consequently, the reverse repo rate under the LAF remains at 5.75 percent, and the marginal standing facility (MSF) rate and the Bank Rate at 6.25 percent.”
A footnote in small print said:
“From this resolution onwards, growth in the gross domestic product (GDP) will be used as the headline measure of economic activity.”
The shift from Gross Value Added (GVA) methodology to Gross Domestic Product (GDP)-based measure to compute growth estimates, stated to be to conform to international standards, was best explained by Deputy Governor Dr Viral Acharya during a media interaction as under:
“Globally, the performance of most economies is gauged in terms of gross domestic product (GDP). This is also the approach followed by multilateral institutions, international analysts, and investors, and primarily they all stick to this norms because it facilitates easy cross-country comparisons”. While GVA gives a picture of the state of economic activity from the producers’ side or supply side, the GDP model gives the picture from the consumers’ side or demand perspective. On the face of it, the change looks rational.
Dr Acharya observed that the Central Statistical Office (CSO) has started using GDP as the main measure of economic activities from this year.
Former Deputy Governor of RBI Ms Usha Thorat, in her column in Business Line, identified ‘a lower market borrowing programme with higher share of floaters and short-term bonds, permission to spread the bond MTM provisions over the entire year and deferment of implementation of Indian Accounting Standards (Ind AS) by one year’ as welcome positives and recalled Dr Acharya’s yet another thoughtful observation: “It is best for sake of policy credibility to not mix instruments with objectives they are not meant to target.”
Reserve Bank of India in limelight
Once again all eyes are on Reserve Bank of India. The March 14, 2018 Ahmedabad speech of RBI Governor Urjit Patel (partly covered in the previous issue of TGA) sends out the message that the humility of central bankers is not indicative of the central bank’s willingness to accept insults lying down. The arrogance of central banking is a time-tested antidote for several fiscal maladies.
The quote from I G Patel (1993) at the beginning and Bimal Jalan’s 2007 speech on “Ethics of Banking” (See box for excerpts ) are evidence enough to show that RBI had Governors with vision to see future and what was lacking in bringing about the changes they envisioned about reforming policies and procedures was, and is, the support from GOI which lack the will owing to political constraints.
Ethics in Banking
If rules of ethical behavior in banking were to be intrinsically dependent on ethical behavior in politics, or for that matter, in different segments of trade and commerce, then we are likely to be faced with an insoluble problem. Against this background, is there anything further that can be said specifically about ethics in banking, which is the subject of our discussion today?
I believe that, even after taking all the constraints into account, it is still possible to prescribe some rules of behavior which will make banking more ethical in developing countries, particularly in those countries which have an independent judiciary and an accountable administration. Let me move on to some prescriptive suggestions for promotion of ethics in banking for further consideration by central banks, experts and the public in general.
The foremost requirement, in my view, to make our businesses, including banking, more ethical is to insist on standards of accounting and auditing which conform to the best international standards and ensure full financial disclosure. Banks, in particular, deal with other people's money. They are intermediary institutions which have been set up and licensed to accept deposits from the public, most of which are small in magnitude. They then lend such deposits to other users and producers for carrying out their business activities, which in turn are expected to generate employment and growth for the country as a whole. This intermediary function places a special responsibility on the banking sector. It is of utmost importance to ensure that there is complete transparency in respect of the use of depositors' money and ensuring the safety of funds.
As the sub-prime crisis in the US and the UK has recently demonstrated, non-transparency and non-disclosure of financial obligations is not confined to developing countries alone. For all our countries, in the light of recent experience, it has become doubly important to revisit the banking, auditing and accounting standards and lay down guidelines which would ensure full disclosures of all obligations, including "off-balance-sheet" items.
One important ingredient of the proposed review of disclosure and accounting standards is to eliminate excessive secrecy that now prevails in regard to banking operations in many of our countries. I do not know enough about the situation in Bangladesh, but I know that in India, banks enjoy considerable legal protection in respect of disclosing the identity of borrowers as well as defaults and rescheduling of outstanding payments. This non-disclosure is further buttressed by the Official Secrets Act, 1923, which protects government ministries and departments from disclosing anything in respect of formal or informal directions given by them to banks, regulatory authorities and other financial institutions. I see no reason why names and amounts lent by banks to individual borrowers should not be disclosed, and why even defaulters should enjoy the benefits of secrecy provisions.
The rationale for reducing the scope of secrecy provisions is to ensure that actions taken by banks conform to the normally accepted banking and regulatory guidelines, and are not unethical at least on the face of it. Public disclosure would also ensure some exercise of caution by banks in their lending operations, and in granting benefits to borrowers by way of rescheduling and so on. All such operations should not only be reasonable but also perceived to be so by the general public.
A difficult and somewhat thorny issue in regard to regulation and management of the banking sector is the role of politics in determining outcomes. In most developing countries, there is a strong view that banking and financial operations should be conducted to promote growth with equity, and special attention should be given to the poorer sections of the people in granting access to bank loans. In several countries, there are specific provisions in regard to quantum of lending that should be directed to persons below the poverty line and certain other categories of borrowers. Since these provisions are meant to serve the interests of the people, peoples' representatives in Parliament and ministries claim to have a direct role in ensuring that banking operations conform to governmental priorities.
This view has substantial validity and must be respected as an important aspect of democratic accountability in developing countries. However, while ensuring public accountability for banking operations, it is equally important to ensure that political affiliations do not become the primary criterion for selection of top management or directors of banks. The objective of political neutrality in the appointment of top management and directors can be met if the same processes are put in place for such selection as is presently the case for initial appointment of members in different civil services.
In several countries, civil servants are normally appointed through an open competitive examination process which is conducted by an independent institution, such as the Union Public Service Commission. There is no reason why a similar mechanism, at arm's length from the political executive, cannot be set up for the choice of top management and boards of directors in public sector banks. Selections can be made by an independent statutory Commission by inviting applications from qualified professionals and/or through appropriate search committees. The process for selection should be open and well-advertised. So far as private sector banks and other financial institutions are concerned, it is desirable for the government not to have any role in the selection process.
The point is simply that while financial priorities and banking policy may be decided at the political level, with due accountability, the political executive should not have any direct operational role in the choice of persons to run banks and other financial institutions. Such a process should ensure that, while there would always be some exceptions, the management and boards of banks are independent in their functioning and are not beholden to the changing political leadership for their appointments.
(Excerpts from the Speech by Dr. Bimal Jalan, Governor, RBI, at the 7th Nural Matin Memorial Lecture, Dhaka, July 20, 2007)
As acknowledged earlier in these columns, since inception, Reserve Bank of India has been fortunate to have at its top, several eminent personalities who happened to be there, attracted not by the ‘compensation package’ or the opportunity to ‘improve their CVs’ for the next assignment, but by the challenges the institution provided to test their fitness for being associated with India’s economic development. While making this observation, I have in mind Governors from Sir Osborne A Smith (1935-37) to Urjit Patel (2016- till date) and several Deputy Governors including D R Mehta, R V Gupta, S S Tarapore and Viral Acharya. The number of Governors and Deputy Governors who were misfits cannot go beyond that you can count on the fingers of one hand!
“Those were the days…When Prime Minister Manmohan Singh visited RBI. From L to R: Shri S Venkitaramanan, Dr C Rangarajan, Dr Manmohan Singh, Shri M Narasimham, Dr Bimal Jalan and Dr Y V Reddy.” Image courtesy: RBI Website
Arrogance of central banking
No, this sub-caption has nothing to do with Urjit patel’s much debated March 14, 2018 speech. “The Humility of Central Bankers and the Arrogance of Central Banking” was the theme of SS Tarapore’s address in a ‘closed door interaction’ at the RBI Auditorium, with his colleagues on September 30, 1996 the day he had retired as Deputy Governor (included as Chapter 16 in his book ‘India’s Monetary Policy in the Crucible of Reform’ Vision Books, 2000). Excerpts:
“…We, in the Reserve Bank, need not be apologists for being zealous about inflation control. In fact, one should not be ashamed to be evangelical about our stance. As Dr Manmohan Singh poignantly put it, inflation hurts the weakest segments of society the most and there can be no better anti-poverty programme than the control of inflation. Far from being defensive about our policy stance, our critics must be told that excessive creation of money is a sure invitation to inflation and if hurting the poor is a sin then the advocates of a permissive monetary policy are the sinners of society. It is naïve to claim that we can kick-start the economy and that the printing press can generate an output of steel, cement, and machinery. It hardly needs to be stressed that excessive creation of money would merely result in inflation. We need not be overtly concerned by the esoteric punditry which claims to coax growth out of created money. Responding in 1979 to critics who argued that we need not take a squeamish or alarmist view of a sizeable increase in money supply, Dr I G Patel, the then Governor with some element of agony said: “I am afraid this country of ours, great and blessed as it is, enjoys no such divine dispensation of immunity from monetary laws….”
Thus far about monetary policy and inflation. We will jump over to something equally important after reading about three sins Tarapore exhorted central banks to avoid. He said in the above speech:
“…A central bank must strengthen its balance sheet as it can face very intense fluctuations which can have an adverse impact on its balance sheet and ultimately there is no one who can take care of the central bank if it mismanages its balance sheet. I have on earlier occasions referred to the “sins” of central banking and we must be arrogant enough to refuse to commit these sins. A central bank is a unique institution in the sense that it can expand or contract its balance sheet as a matter of deliberate policy and there is a danger that the central bank can be easily persuaded into imprudent policies. To briefly recapitulate these three sins are: (i) Automatic monetization of the budget deficit, (ii) Payment of interest on banks’ cash balances with the central bank and (iii) The provision of various types of exchange risk guarantees……Avoiding these three sins go to greatly strengthening the quality of the balance sheet of the Bank which is clearly of advantage to the economy as a whole…”
The quote is also in the context of GOI’s exerting pressure on RBI to pay dividend on RBI’s capital (which remains static at Rs 5 crores since inception) on the basis of expectations expressed in union Budgets and the unusual open bargaining during FY2018 for advance transfer of ‘surplus income’ more than three months prior to June 30, 2018 (RBI’s accounting year is July-June). In earlier issues, we have discussed depletion of RBI’s reserves to an all-time low during 2013-16.
Currencies outside the monetary system
Reserve Bank of India recently made an observation that central banks around the world were exploring the option of introducing fiat digital currencies, keeping in view the rapid changes in the landscape of the payments industry along with factors such as emergence of private digital tokens and the rising costs of managing fiat paper/metallic money have led. Taking note that many central banks are still engaged in the debate, RBI has constituted an interdepartmental group to study and provide guidance on the desirability and feasibility to introduce a central bank digital currency. The Report is expected to be submitted by end-June 2018. A recent RBI notification had this to say on virtual currencies:
“Ring-fencing regulated entities from virtual currencies Technological innovations, including those underlying virtual currencies, have the potential to improve the efficiency and inclusiveness of the financial system. However, Virtual Currencies (VCs), also variously referred to as cryptocurrencies and crypto assets, raise concerns about consumer protection, market integrity, and money laundering, among others. Reserve Bank has repeatedly cautioned users, holders and traders of virtual currencies, including Bitcoins, regarding various risks associated in dealing with such virtual currencies including Bitcoins, regarding various risks associated in dealing with such virtual currencies. In view of the associated risks, it has been decided that, with immediate effect, entities regulated by RBI shall not deal with or provide services to any individual or business entities dealing with or settling VCs. Regulated entities which already provide such services shall exit the relationship within a specified time.”
As a follow-up RBI issued the following instructions to banks:
“Reserve Bank has repeatedly through its public notices on December 24, 2013, February 01, 2017 and December 05, 2017, cautioned users, holders and traders of virtual currencies, including Bitcoins, regarding various risks associated in dealing with such virtual currencies.
2. In view of the associated risks, it has been decided that, with immediate effect, entities regulated by the Reserve Bank shall not deal in VCs or provide services for facilitating any person or entity in dealing with or settling VCs. Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer/receipt of money in accounts relating to purchase/ sale of VCs.
3. Regulated entities which already provide such services shall exit the relationship within three months from the date of this circular.”
This move by RBI has attracted mixed responses from media and analysts. Some termed it most retrograde. Let us read what Vaibhav Parikh and Arvind Ravindranath (both are lawyers with a law firm) said in an article published in Business Standard on April 10, 2018. The article opens with the following interesting observations:
“Strangely, the internet was also once feared as a product of technology. When the internet was new, criminals were the first ones to adopt it.
Believe it or not, there were calls to ban the internet. Once people realized the benefits of the internet, they focused on rooting out the criminal activity and not at banning the internet. It is for this reason that the Reserve Bank of India’s (RBI) recent move can be termed it's most retrograde.”
Other comments by the learned lawyers include the scare about the possibility of only the legitimate players in the field (of virtual currency) getting affected, trade in the fast-growing virtual currency space moving overseas, tax evasion on account of transactions not going through banking channels and so on. Let us assume, the authors of the article were ignorant of RBI’s study group on the subject whose report is expected in June 2018.
(The writer is a Mumbai-based consultant and author of “India’s Decade of Reforms: Reserve Bank of India at Central Stage” (2018, Notion Press))