During the First World War, India spent more than 8 per cent of its GDP to finance Britain’s war effort. About half of that money went as direct cash contribution, a fifth went in low-interest loans and the remaining went in kind. This massive drain should have caused inflation, raised interest rates and weakened the rupee. But, the British Empire managed it through price controls, interest rate ceilings and by not letting the rupee-pound exchange rate budge, till the war was over.
This was fine as long as British officials in India were gaining as well. But, after the war ended, the Rupee was allowed to weaken and that meant the money officials of the Raj earned in India converted into fewer Pounds when they sent it home. This trouble with ‘remittances’ was one key reason why the Viceroys’ officers in India began sparring over financial independence with the India Office in London.
This stand-off between two sides of the coin of the British ruling establishment, ended up in a peculiar truce – the founding of the Reserve Bank of India on All Fool’s Day in 1935. The RBI accorded some semblance of financial autonomy to the officials of the British Raj on the ground, but it also ensured that the ‘London market’ would continue to control it.
- RBI was founded in 1935 to sort out the remittances issues of the British officials and it was subordinated to London.
- Post independence, RBI was nationalised and the bank’s task was expanded to finance the government’s development objectives.
- Nehru outlined that the RBI was independent like any other government department, but it was within the government sector.
- Inflation shocks of the 1970s and 80s forced the RBI to take a more neoliberal stance.
- There have always been spats between the RBI and the different governments over the bank’s role and autonomy.
- Under Modi government, RBI’s task has come down to one single thing – the neoliberal idea of ‘inflation targeting’.
London’s key objective was to maintain control over India’s finances, even if pressures from the national movement forced the Empire to concede a limited amount of political autonomy to Indians. The RBI’s board had to be “white and sensible, and not black and political.” It had to be “Hindoo marriage” between the Bank of England and RBI, where the wife would advise but do what she is told.
Ironically, this subordination of the RBI to London, was done in the name of keeping it outside the ‘political’ control of the government. This was going to change after Indian became independent, and the RBI was nationalised and brought under the Indian constitution. From the very beginning, the bank’s task was expanded to finance the government’s development objectives, especially those outlined by the Planning Commission after 1950.
First Clash Between RBI and Government: Blame it on Nehru?
It didn’t take long, however, for the government and the central bank to clash. In 1957, Sir Benegal Rama Rau, the second RBI governor of post-Independence India got into spats with Nehru’s finance minister, the industrialist TT Krishnamachari. When Rau complained to Nehru, the Prime Minister drew the line on central bank independence. The RBI is “centrally autonomous,” Nehru wrote in a letter to Rau, “but it is also subject to the central government’s directions.” Nehru’s statement might sound contradictory, but in effect, he was pointing out that the RBI was independent like any other government department, but it was within the government sector. It had to operate in unison with government policy.
The Nehru government’s view about central banking was no different from what was happening in the rest of the world.
Governments, across the globe, were spending huge amounts of money for post-war reconstruction of their economies and to stabilize their war-ravaged populations. Central banks were subordinated to this effort. They had to finance government spending, impose capital controls, manage exchange-rates to protect local industry, allocate credit at subsidised interest rates to priority sectors that promoted employment.
RBI and the Inflation Shocks of 1970s
This worked till governments were stimulating demand and expanding capacities. But, the 1970s changed that, when the global oil-shock caused massive inflation. This was accompanied by economic stagnation in the once-booming developed economies and a resulting increase in unemployment. Governments cut back on spending and central banks now reoriented themselves to curbing inflation.
From the 1980s, developed countries increasingly turned to monetary policies to manage their economies.
Welfarism gave way to ‘Reaganomics’. Economic policy was now oriented towards encouraging private enterprise and the profit-motive.
How could this be done? By controlling wages and the cost of finance. The first needed inflation to be kept in check so that the cost of labour remained stable, and the second required interest rates to be low, so that capitalists could get cheap loans. And to compensate finance capital for low interest rates, capital controls had to be removed, so that it could seek out new investment opportunities which gave higher returns.
RBI’s Reluctant ‘Neoliberal’ Role in the 1990s and Later
In India, the RBI took much longer to adapt to this new ‘neoliberal’ role. In 1991, when the Rao-Manmohan reforms were unleashed on the Indian economy, most Finance Ministry babus were trained in old-school licence-quota raj economics. They had a steep learning curve and monetarism wasn’t there cup of tea. Finance Minister Manmohan Singh, on the other hand, had been RBI governor in the early 1980s. He worked very well with his former deputy C Rangarajan, who was to become the RBI chief from December 1992.
Ironically, successive governments wanted to push the RBI into an independent monetarist role, even when the governors themselves were not too keen to push neoliberal reforms.
This caused some public friction, every now and then, the most famous of which was the one between P Chidamabaram and RBI governor Yaga Venugopal Reddy.
As Finance Minister Chidambaram wanted to open up Indian Banks to foreign shareholding. Reddy opposed it, saying that it could weaken domestic control over India’s banking system. The Chidambaram-Reddy spats became so open that the RBI boss had to be called by the Prime Minister and told to take it a bit easy. Reddy agreed and even offered an unconditional apology to the Finance Minister. Soon a journalist asked the governor how autonomous the RBI was. “The RBI has full autonomy,” Reddy replied. “I have permission of my finance minister to tell you that.”
Why RBI Has Had More Spats With Governments Recently?
Since then, almost every RBI governor has had run-ins with governments – Duvvuri Subbarao, Raghuram Rajan, and even the more pliant Urjit Patel. Usually, it has been about Reserve Bank autonomy, and its right to determine interest rates and credit policy. Since the Global Financial Crisis of 2008, Finance Ministers have wanted the RBI to juggle monetary policy and deliver low-inflation, low interest rates and a relatively strong currency. This has usually been impossible to achieve, and that has often caused the government to vent their frustrations in public.
The Modi government has given the RBI an added task – of fixing India’s massive bad-loan problem.
Raghuram Rajan tried some of it, by making banks reveal their true bad loan numbers, trying to get lenders on the same platform and monetise underlying assets. Rajan’s public statements about the government’s economic policies and on communalism, ensured that he didn’t get a second term.
The man who replaced him, Urjit Patel, was perceived to have a better relationship with Modi Sarkar. He had to preside over the demonetisation disaster and absorb some of the blame for the chaos it unleashed. However, Patel fell foul with the government when he opposed its claims to the RBI’s reserves to finance budgetary spending. He resigned after less than two and a half years as RBI governor.
RBI’s Single Task These Days: Inflation Targeting
As far as RBI autonomy was concerned the clock had turned full circle. Patel’s replacement, Shaktikanta Das had been the Economic Affairs Secretary in the Modi government till he retired in May 2017. It didn’t take him long to handover Rs.1.76 lakh crore from the RBI’s reserves to the Modi government. Since then, he has cooperated closely with whatever the government has wanted, cutting interest rates repeatedly to boost a flagging economy.
Despite the turf-war between the government and the RBI, both are agreed on what the central bank needs to do. Its task has come down to one single thing – the neoliberal idea of ‘inflation targeting’. The bank no longer cares much about how to stimulate lending, how to generate employment, how to give the poor better access to credit. It intervenes in the economy with a single-minded focus – to ensure inflation stays with a narrow range.
In some senses, this is a source of empowerment for the RBI, because its monetary policies have now become the central instrument to regulate the economy. On the other hand, it is a great erosion of the social role of India’s central bank. Where once it regulated the flow of money to promote India’s industry, help create jobs and protect India’s financial security, today it has become a one-trick pony.
(The author was Senior Managing Editor, NDTV India & NDTV Profit. He now runs the independent YouTube channel ‘Desi Democracy’. He tweets @AunindyoC. This is an opinion piece. The views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)
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