Who is calling the money shots?

Who is India’s monetary authority? Is it RBI or Ministry of Finance? Traditionally RBI it is but of late the center of gravity is shifting more towards North Block. The pattern is too obvious not to be noticed—the real decision-makers are now in the central secretariat in New Delhi. Ideological divide, perhaps? RBI remains the statutory authority, but it is an open secret that the man in charge is P Chidambaram. A peskily independent RBI governor has retired, and a strong-willed finance minister has made sure that he will not be faced with another situation where his views are either ignored or not acted upon.

First, a new governor of Reserve Bank of India was appointed and, in a symbolic departure from past practice, the new incumbent went across directly from the finance ministry. Then, a new ‘liquidity committee’ was set up, chaired by the finance secretary. Now, a new economic advisor with a strong background in finance has been appointed in the Prime Minister’s office. A day later, the finance minister calls the heads of the state-owned banks with the intention announced in advance that he wants bank lending rates to drop. On cue, immediately after the meeting, one bank chief after the other announces interest rate cuts.

Critics of Dr.G.V.Reddy (Raghuram Rajan and Percy S Mistry) often argued the western orthodoxy that RBI should focus on a single objective of achieving a target rate of inflation. They usually oppose central bank interventions in the currency market, want quicker movement towards capital account convertibility, greater integration with global financial markets and the introduction of sophisticated financial instruments. But traditionalists supported Dr.Reddy with the counter-view that the financial crisis that has gripped the western world is not an advertisement for financial integration, that India can do without the periodic financial crisis that has consumed other developing countries with open capital accounts.
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I like a hybrid. Coming from a business family and community, one can understand why Chidambaram is hawkish on stock markets (except in matters of FDI ceilings where he surprisingly shoots down CCEA and DIPP moves seeking to allow FII to breach them). While RBI should indeed be the strategic authority, constructive suggestions from Ministry of Finance and other regulatory authorities can be heeded if not obliged. Controlling inflation is indeed the primary responsibility of RBI, but inflation is not the outcome of monetary logistics – it is rooted in market demand and supply imperatives. RBI can at best control money supply, hike or cut CRR, SLR or Repo rates but it can’t stop you from paying a higher price or ask you not to buy stuff. It could not even bring down the inter-bank call rates that hover around 11-12% as opposed to the normal 2-3%, despite the recent rate cuts. That can only be possible if the economy has multiple sources for fund flows. It can infuse or squeeze out liquidity to an extent, but it can never replace a generous flow of funds coming from a buoyant global sentiment. Over-indulgence by either would lead to catastrophic outcomes.

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