From Point of No Return, Urjit Patel Had Only One Way to Go – Out

Patel’s is neither the first nor will be the last resignation on a difference of opinion with the government.

(Photo: The Quint)

Those bemoaning the resignation of Reserve Bank of India (RBI) Governor Urjit R Patel, through clouded prisms of politics, and shedding crocodile tears need to consult neuroscientists and have their memories checked.

This is the same man whom they had condemned as being a stooge of the Narendra Modi government because he signed-on on demonetisation two years ago. But, we’ve seen enough U-turns in politics and among the politicised to expect any better.

Of course, it is bad that Patel, a fine economist, has had to resign. It is terrible that despite his words – “personal reasons” – Patel’s resignation comes in the middle of arguably the loudest debates around the central bank’s independence.

It is worse that the resignation comes as India settles down to vote in the next General Elections, six months from his date of resignation.

This resignation should not have happened. RBI and the government should have done better.

Power Tussle Between RBI & MoF

Now, let’s get to the real issues. The public spat between RBI and the Ministry of Finance (MoF) raises two key issues. First, who holds the power when there is a conflict between RBI and the government? And second, how do we situate the idea of central bank independence in a democracy?

Created under the Reserve Bank of India Act, 1934, Parliament has given the government the power to issue directions to the central bank. Section 7 under Chapter II of the Act clearly allows the government to give directions to RBI that it may “consider necessary in the public interest.”

Thus, if the government views issuing directions as a matter of public interest, it does so based on the powers given to it by law.

An issue that remains unexplored is, that while nobody wants the government to use Section 7 and give directions to the RBI, the provision to do so exists in law. Moreover, the power to use it rests with the government alone, and it can decide to use it if it considers it necessary “in public interest.”

That Parliament, while enacting this law, considered it a necessity and left it to the government’s discretion to use it, reflects a party-neutral political will behind this section.

Such provisions of giving directions are part of every law under which all regulators function – Section 16 under Chapter VII of the Securities and Exchange Board of India (SEBI) Act, 1992; Section 18 under Chapter VI of the Insurance Regulatory and Development Authority (IRDA) Act, 1999; and Section 42 under Chapter X of the Pension Fund Regulatory and Development Authority (PFRDA) Act, 2013.

This provision exists for regulators beyond finance – Section 25 under Chapter VI of the Telecom Regulatory Authority of India (TRAI) Act, 1997; Section 55 under Chapter IX of the Competition Act, 2002; Section 85 (1) under Chapter XII of the Food Safety and Standards Act, 2006; and Section 83 (1) under Chapter X of the Real Estate (Regulation and Development) (RERA) Act, 2016.

Further, the legislative control in favour of the government does not end at giving directions. Lawmakers have gone a step further and given the government the powers to supersede the governance systems of regulators.

Section 30 of the RBI Act enables the government to supersede the Central Board if RBI “fails to carry out any of the obligations imposed on it by or under this [RBI] Act.”

Following this, the government needs to place a full report of the circumstances leading to such action and of the action taken before Parliament within six months.

Similar provisions exist for all other regulators too under Section 17 of the SEBI Act; Section 56 under Chapter 9 of the Competition Act; Section 19 of the IRDA Act; Section 44 of the PFRDA Act; and Section 82 of the RERA Act.

The two provisions of giving directions to regulators and superseding them, come with restraints that can be called, at best, prerogatives. They range from questions of policy (with the authority to declare whether it is a policy decision or not vesting with the government) to the inability of the regulator to discharge its functions and duties; default in complying with directions; and compromising the sovereignty and integrity of India, the security of India, public order, decency or morality.

These provisions grant the government unambiguous powers to give directions or supersede the governance of a regulator. In the current case of the RBI, directions under Section 7 can be imposed in the public interest, after consultation with the governor, while the board can be superseded if the RBI fails to carry out its obligations. For anyone else – the regulator, the Opposition, the expert, the people – to claim otherwise is an extrapolation of an opinion; it will not stand the test of law.

If the nation does not want these provisions, amendments will need to be made. For this, citizens must reach a consensus through the only tools available to democracies for making legislative changes: public debates and discussions, followed by enactment of amendments by Parliament.

However, as long as the provisions exist, they are law and must be followed.

Finally, on the issue of central bank independence, a fashion statement of the 1980s that has lingered on till today, one question remains unasked: independence from whom and to what end?

The most important decision any central bank takes, and RBI is no exception, is about policy rates: repo rate, reverse repo rate, marginal standing facility rate and bank rate.

In India, this function has been hived off, by law, to a Monetary Policy Committee, through a 2016 amendment of the RBI Act. Now, six members decide India’s policy rates: three members from the RBI, including the governor and the deputy governor in charge of monetary policy; and three appointed by the government. Decisions are based on majority vote (of those present and voting), and in case of a tie, the RBI Governor has the casting vote.

Effectively, policy rates are in control of RBI, with which it can undertake inflation targeting – four percent, with an upper tolerance level of six percent and a lower tolerance level of two percent. Once this key determinant of the central bank’s independence has been established by law, it is as free as can be.

Beyond this, RBI has no accountability even on its regulatory actions.

Other regulators have appellate bodies – Securities Appellate Tribunal in case of regulations and orders of SEBI or PFRDA; Telecom Disputes Settlement and Appellate Tribunal in case of TRAI; National Company Law Appellate Tribunal in case of CCI.

However, there is no such appellate body or even a mechanism to review the RBI’s regulatory and supervisory decisions.

It is strange how the law has given the RBI so many exceptions that are in direct conflict with the principle of democratic legitimacy. At some point, these will need to be questioned and changes in tune with democratic institutions enacted.

On the other hand, the checks on governments come from their accountability to several institutions. To Parliament, where their actions are debated and ministers made answerable through questions by Members.

Further, all actions of the government can be, and often are, tested before the law through the Judiciary. Pressures from the media, particularly social media, add their own weight to accountability.

And finally, accountability comes through the most powerful tool that the public can wield: elections, not merely national, but in states, Panchayats and municipalities.

Through the creation of an office of any regulator, the government is essentially outsourcing the law-making process to this body. Thus, the government proposes a law, Parliament enacts it, a regulatory body is created and tasked with the nitty-gritty of rule-making and sectoral oversight.

The regulatory body cannot be an independent feudal fief or democratically unaccountable. In case of the RBI, Sections 7 and 30 are instruments of ensuring that accountability.

The crux of the tension between central banks and governments comes from a policy challenge to balance two goals: independence of the central bank from political interference, so it can undertake its monetary policy and regulatory responsibilities freely and without any pressures; and accountability of the economic system, with the government currently holding that responsibility, the mechanism of elections making it answerable.

Pushed to extremes, the two goals are in direct conflict with each other. It is up to those running these two institutions of economic governance – the RBI and the MoF – to come together and deliver outcomes through a process of negotiations. However, when negotiations fail and communications break down or when there is an unresolvable conflict between the two, an institutional answer in the form of decision-making power becomes necessary.

That power is unambiguously in the hands of an accountable government instead of an independent regulator – as it should in a democracy.

Decoding Patel’s Exit - What History Tells Us

Irrespective of how badly it has panned out or how it could have been handled better, this is the legislative context of Patel’s resignation. By leaving, Patel is effectively telling the government that matters have reached a point of no return and the only action he can take is to leave.

His resignation is right morally and legally – and in tune with history.

Patel’s is neither the first nor will be the last resignation on a difference of opinion with the government. The first public spat happened in October 1936, when the first Governor of RBI, Osborne Arkell Smith, resigned after only 18 months in his post, two years before his term was to expire due to serious differences of opinion between him and then Finance Member of the Viceroy’s Executive Council James Grigg and his deputy James Taylor around the issue of lowering of the Bank rate.

In January 1957, following a tiff with then Finance Minister TT Krishnamachari, RBI Governor Benegal Rama Rau had to resign. Apart from public criticism of Rau, Krishnamachari had announced a stamp duty on bills and termed it a “fiscal measure with monetary intent,” openly hijacking the RBI’s monetary policy mandate. In the ensuing negotiations, Prime Minister Jawaharlal Nehru made it clear to Rau that the RBI was part of the activities of the government and had to keep in line.

Fast forward a quarter of a century to 1983 and, under Prime Minister Indira Gandhi, Governor Manmohan Singh was brought to the brink of resigning. Singh believed that if the UK-based Swaraj Paul’s Caparo group of companies was allowed to buy shares of Arun Nanda’s Escorts Ltd, it would make it difficult to enforce foreign exchange regulations.

This view conflicted with Gandhi’s. The rift increased when Gandhi cleared a proposal to give a banking licence to the controversial Bank of Credit and Commerce International (BCCI).

“We had to give the licence because the government forced us to,” Singh said. However, he then sent his resignation to Finance Minister Pranab Mukherjee as well as to Gandhi.

Three decades later, with Singh as prime minister, the conflict tables turned, this time between Finance Minister P Chidambaram and Governors YV Reddy and Duvvuri Subbarao. Seeking growth, Chidambaram sought lowering of interest rates, which first Reddy and later Subbarao rejected. When the issue of extending Subbarao’s term came up, it took Singh to facilitate it. Four years earlier, in 2008, his predecessor YV Reddy had considered resigning on the issue of opening up the banking system to foreign ownership.

These tensions are not restricted to India. In March 1953, the first Governor of the Central Bank of Ireland Joseph Brennan resigned following disagreements with the government over economic and financial policy matters.

In his conflict with Finance Minister John Fleming, Bank of Canada’s Governor James Coyne resigned six months before completing his seven-year term in July 1961. In 1989, in his fight with German Chancellor Helmut Kohl over currency in the unification of East and West Germany, President of Bundesbank (the German central bank) Karl Otto Pohl resigned.

Today, these tensions are bubbling across the world, from the US and the UK, Switzerland and Brazil, Mexico and Greece.

India is not an outlier. Under Prime Minister Narendra Modi’s tenure, there are echoes of the same conflict between Finance Minister Arun Jaitley and Governors Raghuram Rajan and Patel.

All of us who track the sector expected that as the governance architecture gets more complex from the 20th to the 21st century, there would be a greater sophistication in the way this delicate relationship functioned, through respectful negotiations, informed arguments and policy analyses. Patel’s resignation has ended that hope.

It has also strengthened the one lesson we’ve seen repeat since Rau’s resignation six decades ago: there is only one direction an RBI Governor can take after reaching a point of no return – out.

(Gautam Chikermane is Vice-President at Observer Research Foundation and author of a recent paper titled - RBI versus the government: Independence and accountability in a democracy.)

(This is an opinion piece and the views expressed are the author’s own. The Quint neither endorses nor is responsible for them.)