Is the RBI Really Independent?

Wed, 30 Nov Pre-Open

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We're 21 days into Narendra Modi's demonetisation policy, and people are still confused about what is legal and what is not. Rarely has a government policy affected so many Indians so directly. The merits of the policy - its utility, long-term impact, and outcome are still a matter of debate. What about its legality?

The demonetisation was effected through a notification under the RBI Act, 1934, Section 26: 'On recommendation of the Central Board the Central Government may, by notification declare that any series of bank notes shall cease to be legal tender.'

The point here is very clear that the central board of the RBI plays a central role in all decisions related to the currency, the issue of notes and in turn, the discontinuance of bank notes of any denomination.

But this does beg the question, did the government use Raghuram Rajan's exit to push demonetisation thorough?

According to an article in The Quint, Rajan was opposed to the concept of demonetisation. While he has not commented on the government's current decision yet, in 2014 Rajan, in a public lecture, questioned the effectiveness of demonetisation.

• Unfortunately, my sense is the clever find ways around it. They find ways to divide up their hoard into many smaller pieces. You do find that people who haven't thought of a way to convert black to white, throw it into the Hundi in some temples. I think there are ways around demonetization. It is not that easy to flush out the black money.

Despite Rajan's opposition, a few months after his term ended, the government announced the withdrawal of Rs 500 and Rs 1,000 currency notes. Urjit Patel's silence along with serious disconnect between the RBI and the government on the implementation of demonetisation, and frequent changes in rules points to absence of coordination.

There are varying views on the extent of damage the currency crunch can inflict on the economy. Some are predicting that the move could hit the economic growth. Others question whether the long-term gains will outweigh the losses. The RBI's refusal to provide adequate information on the rationale and economic consequences of demonetisation appears to be creating significant information asymmetry in the market. The BSE Sensex has lost about 4% since 8^th November.

Urjit Patel's low profile which was initially perceived as a foil for Narendra Modi's high-visibility, could backfire. Credibility and autonomy of the Reserve Bank of India is linked to the value that investors assign the currency, which is sliding toward a record low against the US dollar.

With the decision now taken, the ball is now in Urjit Patel's court. How Dr Patel manages the economic fallout of the withdrawal of currency notes is being be closely watched. If he fails, the demonetisation episode would be remembered as an event when RBI compromised its functional autonomy.

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