India’s central bank and its new governor are facing a barrage of criticism over their role in the recall of 86 per cent of the country’s currency, with a growing chorus casting doubt over the independence and competence of one of the country’s most important institutions.
Urjit Patel was just two months into the top job at the Reserve Bank of India when Narendra Modi, the prime minister, announced the demonetisation in early November. The sudden move caused chaos across the cash-driven economy, with replacement notes initially incompatible with the nation’s cash machines and unavailable in sufficient quantities, despite being strictly rationed.
The sudden move has led critics to complain that the government, with RBI complicity, rushed through a policy that should first have been carefully weighed and recommended by the central bank, undermining its independence.
“The role of the central bank in our economy is under threat and it’s a national problem,” YV Reddy, a former RBI governor, said in a recent interview.
The RBI’s approval was needed for the government to proceed with demonetisation but many have questioned how much it was really involved in formulating the most significant Indian monetary policy decision in decades. According to a briefing sent by the central bank to parliamentarians in December, it only recommended the plan a day after being “advised” by the government to consider it.
“The governor allowed the government to encroach upon the central bank’s territory,” said P Chidambaram, a former finance minister for the opposition Congress party.
The RBI had noted that the “decision to withdraw the legal tender could be made” because a “critical minimum” of new notes had been printed — a claim called into question by the subsequent scramble for cash across the country.
Amid growing criticism over the sequence of events that led to the move, the government issued a statement at the weekend supporting the RBI and hitting back at those who “have alleged infringement of the autonomy” of the central bank.
“It is categorically stated that the government fully respects the independence and autonomy of the Reserve Bank of India,” the finance ministry said.
Beyond the decision-making process, the RBI’s execution of the policy has come under fire for a perceived lack of preparedness, a slew of changes to the rules once the policy had been announced and a dearth of communication about the unprecedented economic experiment.
“The RBI has managed demonetisation in an incompetent and unprofessional manner,” said Mr Chidambaram. “They were completely unprepared.”
Mr Patel has come under particular criticism, with critics comparing the new governor unfavourably to his predecessor, Raghuram Rajan. Mr Patel took the top job at the RBI in September amid suggestions Mr Rajan had been pushed out by the government because of his outspoken views on topics such as crony capitalism and social intolerance.
“Rightly or wrongly, the market has taken the view that this would never have happened under Rajan and I don’t think it’s an exaggeration to call it a fiasco,” said Paul McNamara, an emerging-markets debt portfolio manager at GAM in London.
After more than two months of economic disruption in which the governor has given only two press conferences, observers have questioned the RBI leadership’s apparent reluctance to communicate with the public.
“What has made the situation worse is just this silence,” said Rajeev Malik, an economist with CLSA.
Nevertheless, the central bank is being given the benefit of the doubt by some because of its record of competence and its new inflation-targeting framework.
The demonetisation episode “has cast a shadow over the RBI’s competence and independence [but] we still think that this institution is a very credible one, and in terms of its conduct of monetary policy, it’s a very mature institution”, said Kyran Curry, a Standard and Poor’s analyst.
Erik Lueth, global emerging market economist at Legal & General Investment Management, said the RBI’s management of a one-off event was only a side issue for international investors.
“These kind of currency reforms happen every 30 years, if they happen at all,” he said. “So, even if the RBI is bad at that, what does it matter to us? Setting interest rates happens once a month — so as long as they do a good job there, foreign investors wouldn’t really care”.
However, others said long-term damage had been done to the central bank. “This was the biggest decision on monetary policy that India has ever made and the RBI was nowhere to be seen,” said one recently retired civil servant. “That has compromised it for years to come.”