Stir it up

In a major new speech, RBI Governor D. Subbarao — beginning his second year in office — marshals many facts to make a long and complex argument with but one conclusion: there is nothing wrong with the role and function of the RBI. So much so that one is reminded of similar speeches from the agencies of socialist India, whether it was the old Controller of Capital Issues, the old MRTP, or the old DoT: brave speeches were made featuring all kinds of complicated analyses, which always concluded that everyone else in the world should reform, but not my own agency. Better was expected of Subbarao, an outsider to the RBI when appointed governor. Remember the heart and soul of the RBI is the RBI Act of 1934, which lays out its functions. Drafted by the British in the '20s, it features an unlikely collection of functions dumped into one agency — a product not only of the underdeveloped economics of the '20s but also perverse colonial incentives.

The right way to plan the RBI's future is to look for a combination of political independence coupled with tight accountability. This requires us to do four things: first, narrowing down the RBI's functions to a core, where independence is actually required; second, achieving a high transparency in its decision-making; third, publicly disclosing the monetary policy rule as is recommended in the best-managed economies; and fourth, having the accountability mechanism of achieving a target rate of inflation in the medium term. Subbarao's speech was worryingly silent about any form of accountability. There is, of course, the problem of maintaining financial stability, an issue that he rightly is concerned about. But there are excellent arguments that have not yet been answered — either by the RBI or by Subbarao in this speech — about the location of an authority that would oversee financial stability. In particular, should it not be closer to the finance ministry than the central bank? After all, the quantum of stability desired is a political variable, and one that should perhaps not be entrusted to the unelected senior echelons of the RBI.

Just as the DoT spent many years blocking change, and was ultimately subject to explosive change from the outside, the RBI has chosen to dig in and prevent change. But change is inevitable. There is no role in India's fast-growing future for a central planning agency that micro-manages finance.

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