On resignation of RBI Governor Urjit Patel

What: On Monday, Urjit Patel resigned as the Governor of the Reserve Bank of India, citing “personal reasons”, days before a crucial RBI board meeting to discuss “governance reforms”. This is the first such resignation in post-liberalisation India.

Why did he resign: Patel’s resignation is being read as a consequence of the ongoing tussle between the RBI and the Finance Ministry on multiple issues that had a bearing on the independence of the RBI.

These tensions came into full public spat in the last week of October when deputy RBI governor Viral Acharya said in a speech that a government undermining a central bank’s independence could be “potentially catastrophic”. (I wrote about this in the seventh issue of DisFact)

Former RBI governor Raghuram Rajan called Patel’s resignation a “matter of great concern” adding that “the act of resignation by a government servant or a regulator is a note of protest”.

“I think this is something all Indians should be concerned about because strength of our institution is really important both for growth and sustainable growth in equity and the economy.”—Raghuram Rajan

Read more: India’s elite institutions are facing a credibility crisis (Mint)

What are the issues between RBI and the government? BloombergQuint has details in this piece (it was published on 31st October, but still relevant).

The issues that have cropped up between the RBI and the government range from banking regulation to payment systems and the central bank balancesheet. Neither the government nor the RBI has signaled any thaw of any of these specific issues yet.

These issues were detailed in a speech by RBI deputy governor Viral Acharya in a speech on Friday, which, in many ways, brought the differences between the RBI and the government into the public domain.

Acharya cited demands on the RBI to ease the prompt corrective action framework as one pressure point. Eleven government banks are under this framework, making it hard for them to expand their lending meaningfully. The government has been seeking a relaxation of this framework.

A recent suggestion to create a payment regulator outside the purview of the Reserve Bank has also been opposed by the RBI. In a dissent note, the RBI said that regulation of payment systems is central to the functions of a central bank.

But perhaps the most contentious issue remains that of the RBI’s reserves and capital on the central bank’s balancesheet. (BloombergQuint)

Who’s next: Patel has been replaced by career bureaucrat Shatikanta Das, a former finance secretary and current member of the 15th Finance Commission. Das was the Centre’s face during demonetisation.

More about RBI’s independence: In Mint, Niranjan Rajadhyaksha explains why the breakdown of trust between RBI and finance ministry is a problem and what independence of the RBI really means.

The entire episode of his resignation leaves a bitter aftertaste. The relations between the government and the RBI have been tense for more than a decade now. The smooth collaboration between Yashwant Sinha in New Delhi and Bimal Jalan in Mumbai is now a distant memory. The Indian central bank has been under fire—and insiders have for long claimed that there is a broader agenda to cut it down to size.

One counter view is that there is no such thing as independence from the sovereign in a democratic republic; so central bank independence is a silly demand. This is a straw-man argument. No sensible person believes that a central bank can have statutory independence. The closest any central bank has come to formal independence is the European Central Bank, but it is the creation of a treaty rather than a national government.

The point is not statutory but operational independence is quite a different matter. The RBI does not—and should not—decide its policy goals. They are given to it by law as well as the monetary policy agreement. The governor is also appointed by the government. He needs the operational independence to pursue these goals. The reason this arrangement exists across the world is that a central bank has a different objective function than a finance ministry, even if the final goal is the same. To slip into the language of game theory, governments and citizens are the players in a trust game, while the central bank is designed as a credibility device.

The sort of operating freedom that central banks need to do their job is by nature ambiguous, so formal law needs to be backed by strong norms. That is why the breakdown of trust in recent years is a problem.

From The Hindu editorial:

Mr. Patel’s resignation is bound to raise questions about the Centre’s ability to work with independent-minded economists, coming as it does following the departures of former RBI Governor Raghuram Rajan, who was at odds with the Centre on many issues, and the sudden resignations of Niti Aayog Vice-Chairman Arvind Panagariya and Chief Economic Adviser Arvind Subramanian.

It is true that Mr. Patel’s reclusive and non-communicative style may not have endeared him to some bankers, but his eminence as an economist and his understanding of macro-economic issues is undisputed. Governments have sparred with the RBI before on the issue of autonomy, but the NDA government went one step further by starting consultations under Section 7 of the RBI Act, which gives the Centre the power to direct the RBI to act in specific ways.

Read more:

  1. Urjit Patel: A RBI Governor Most Controversial In BloombergQuint, Ira Dugal looks back at various aspects of Patel’s governorship. This is the best piece I read about Patel’s tenure.

  2. Why Urjit Patel will not be missed as RBI governor In Mint, R. Jagannathan makes a counter argument: he calls Patel’s resignation a “positive development”.

    Any RBI governor needs two skills. One is the ability to communicate, including with the finance ministry, so that the relationship is smooth despite disagreements. The other is the ability to take policy decisions keeping the complexities of the real Indian economy in mind. Patel failed to measure up on both counts.