Economic affairs secretary Subhash Chandra Garg’s tweet in reply to RBI deputy governor Viral Acharya’s hard-hitting speech was widely deplored, but he did have a valid question. To what extent are investors really bothered about central bank independence? If they are, what explains the flood of money that entered China, where the central bank doesn’t even pretend to be independent?
The political economy of central bank independence
In fact, central bank independence has been in vogue only for the last 30 years. Not everybody is enamoured of it. Some academics have argued that rather than being truly independent, central banks have become handmaidens of international finance. Some have alleged central bankers pursue independence as a means of gaining power and prestige. Critics have said that the increasing emphasis on central bank independence is the result of the power of the financial sector to assert its interests, or the interests of creditors, over those of households and debtors, as inflation targeting results in the redistribution of real income from debtors to creditors. Fingers have been pointed to the rise in inequality in recent decades as a result of central bank policies that have led to huge gains for asset markets. In short, central bank independence is closely bound up with the rise to global pre-eminence of the financial sector.
The financial crisis of 2008 hardly advanced the cause of central bankers. Independent central banks in country after country, after having patted themselves on the back for having achieved “Great Moderation” in inflation, couldn’t see the crisis developing under their noses. In India too, the Reserve Bank of India (RBI) hasn’t covered itself in glory in checking the rise of bad loans, or indeed in supervising Infrastructure Leasing & Financial Services Ltd (IL&FS).
However, let’s get back to the example of the Chinese central bank. It is unabashedly an arm of the Chinese state and the prime instrument of the government’s financial repression. It is partly because of its lack of independence that China is sitting on top of a volcanic mountain of debt, a mountain that now threatens to blow its top. However, foreign investors in China were not really bothered about the credibility of its central bank. They banked instead on the credibility of the Chinese government and its track record in managing extraordinary economic growth.
It is, therefore, an empirical matter whether investors repose confidence in the central bank or in the country’s government. In Turkey or Argentina, investors would no doubt prefer central bank independence. In China’s case, they seem to believe it doesn’t matter, as they rather ironically seem to have immense faith in the ability of the Chinese Communist Party to deliver the goods.
The question is: Is the Indian central bank or the Indian government more credible to the financial markets? Whom do they trust more? If demonetisation is an indication of the kind of economic policy preferred by the political leadership, very likely they will prefer central bank independence. They may also prefer RBI governor Urjit Patel’s reticence to the finance ministry’s compulsive political spinning of every bit of news.
Why then is the government insistent on going ahead with needling the central bank? Why initiate a discussion ostensibly on the proper level of RBI reserves at the fag-end of its electoral term? These measures smack of desperation. The government seems to be really scared it will lose the general elections.
There’s also another contradiction. The Modi government had put in place an independent monetary policy committee and made RBI an inflation-targeting central bank. Why take the sheen off these sterling measures by whittling down the independence of the central bank now?
The contradiction in democratic capitalist societies is that while governments have to pursue policies that take care of financial interests, especially foreign financial interests, they also have to face their electorates. As the Roman satirist Juvenal said long ago, what’s needed to keep the masses contented are bread and circuses. The government already has enough circuses—building statues, changing the names of cities, stirring religious passions. Perhaps it doesn’t have enough bread to distribute.
As for the RBI board meeting on the 19th of this month, Patel should try to ensure his name doesn’t go down in the history books merely as the man who said yes to demonetisation.