Wednesday, August 28, 2019

With RBI Move, Team Modi Furthers Bad Economics Credentials

"Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution." Image result for Narendra Modi

Don't say you weren't warned. Prime Minister Narendra Modi has made no secret of his desire to do things differently from every one of his predecessors, and at least when it comes to bad economics, he seems determined to fulfil that aim. The latest achievement is the appropriation of Rs. 1.7 lakh crores from the vaults of the Reserve Bank of India. 

Here's a quick reminder of the context: this is the very issue that led to a crisis within the independent leadership of the RBI last year. Former Deputy Governor Viral Acharya warned against tampering with the RBI's balance sheet in a fiery speech last year that ended thus: 

"Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution." 
Shortly thereafter, Governor Urjit Patel left the institution - we don't know why, but disagreements with the Finance Ministry on its attempts to raid the reserves were clearly part of the problem. 
In the end, no independent regulator can survive the sort of assault that the Modi government has launched on institutions. The RBI lost both Patel and Acharya. The government packed the RBI board with its partisans who then pushed the central bank into agreeing to a committee that would examine the state of its reserves. It then appointed as the new RBI Governor a former Finance Ministry bureaucrat. Thus, it is far from surprising that, in spite of resistance, it has got its way. The long-term imperatives of institutional independence and a strong central bank that controls its balance sheet to manage possible crises have had to give way to Delhi's short-term political priorities. 
Why does the government need the RBI's money? Because it has finally realised the scope of its own mismanagement of the economy. It has expanded expenditure to win the last election, without keeping an eye on how tax revenue was doing. Its neglect of on-the-ground economic reform has caused a major slowdown with jobs being lost across industry, rural distress, and stagnant wages. 
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Other governments would have responded to this slowdown with a fiscal stimulus - but this government has already cheerfully spent the lakhs of crores that it received as a windfall from low oil prices and higher oil taxes. Its bungling of the GST means that it cannot rely on tax revenues. Its failure to privatise means that it cannot hope for too much cash from non-tax revenue. It has already squeezed the public sector for all the cash it can find. And it has already been borrowing heavily, if in a manner concealed from the official budget, so it can't just borrow more and forget it. In other words, it felt that it had no choice but to raid the RBI

The amount that the RBI will hand over is staggering - Rs. 1.7 lakh crore, a percentage point of India's GDP. What is interesting is that this number is very close to another - the "hole" in the government's last union budget. When it was presented to parliament, the budget's numbers seemed good - the fiscal deficit looked under control, targeted tax growth seemed modest, and so on. But that was because the budget simply ignored the real numbers. In actual fact, when you compared the numbers for revenue in 2018-19 in the budget to those from the government's own Controller General of Accounts, there was a Rs. 1.7 lakh crore shortfall. This deception of parliament is problematic, but let's not even go into that. What it reveals is that the GST has underperformed in terms of gathering revenue, and that either the government will have to shrink its spending to match or raise more money. But, as we established earlier, it does not want to do the former and will struggle to do the latter. Thus the RBI has been forced to come riding to the government's rescue. 
For almost the entire tenure of the government, there has been tension between North Block and the RBI. In itself, this is not new - previous governors have clashed with previous political leaders. One RBI leader famously left a few weeks early in 1975 partly because he refused to grant Sanjay Gandhi's Maruti more credit. But India's economy no longer has the socialist orientation it did in 1975 - and it grows more complex and modern every year. For such economies, an independent central bank is essential, one that can take its own decisions about monetary policy, financial stability and reserve requirements. Certainly, those decisions cannot be subordinated to the whims and desires of the political leaders of the day. 
Things could have been worse. The committee that decided on the Rs. 1.7 lakh crore transfer could easily have given the government more - it wanted in excess of Rs. 3 lakh crore initially. On some level, this could be viewed as a compromise between the RBI and the government, allowing the RBI to retain at least some of the disputed capital. But the problem is once such raids are viewed as acceptable, it might not stop there. What happens when this government is next in a similar hole - which, unless it alters its mismanagement and statist orientation, is exactly what will happen. Why would it not decide to squeeze the RBI some more? The problem is with the Modi government's approach to long-term strategic thinking. It may have a vision of the future, but no understanding of how to get there. 
To make India a strong and vibrant economy, you need independent institutions like the RBI. Instead, the government - supposedly in service of its "vision" - seeks to undermine such institutions. This ends up hurting India's prospects. We have nobody to blame but ourselves and the leaders we have chosen. --NDTV

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