Much has been written about the resignation of India’s former RBI governor Urjit Patel. He disagreed with the Modi government on monetary policy and the handling of non-performing assets at state-run banks before quitting his post.
As The Economist noted, the main argument “is the stuff of economics textbooks”. The government wants lower interest rates and a greater share of the Bank’s surplus reserves. This would presumably increase money supply, increase investment in social policies, encourage economic growth, and lead to a boom in the near future. What could be wrong with that?
Not much if you are a government soon-to-be facing tough elections. But as the previously referenced economics textbooks tell us, it would also likely stoke inflation and require a hike in interest rates in the future to meet the target inflation. So, should we take the short-term win or play the long-term game?
Another sticking point in the ongoing RBI v Modi-government saga is how to deal with the non-performing assets of public sector banks. While the RBI proposes tough measures to clean up the banking sector, the government prioritizes continued lending to spur consumer spending and corporate investment.
As with any organization, public or private, the government in power has to balance multiple objectives. But any government faces a “credible-commitment” problem. That is, their decisions may be driven by short-term incentives (such as electoral gains) that undermine long-term policy goals. To combat this issue, one solution is to transfer the decision-making power on certain issues out of the government’s hands and to an independent regulator – an entity established by statute to use legal tools to achieve policy objectives. This entity is supposed to balance the interests of the various stakeholders – governments, users and consumers, and corporate investors. Governments can provide their input to the regulator; but their preferences would have the same weight as those of other stakeholders. Because the objectives of the regulator are not necessarily the same as those of the government in power, they can resist pressures to adopt short-term policies at the expense of long-term policy objectives. And because their mandates are not tied to the electoral cycle, they do not respond to electoral pressures. Problem solved!
At least that is the theory. Around the world, there are a number of regulators in a wide-ranging set of issues, including electricity, airlines, banking, industry, etc. However, the operative word is independent. Regulators will only be effective if they are not unduly pressured by political actors, have the capacity to take and implement decisions, can attract and retain well-qualified board and agency heads, and have the requisite funding. And this is a hard thing to achieve in practice.
Hence the concerns raised by several commentators about the appointment of Mr Shaktikanta Das as Mr Patel’s replacement. He is generally viewed as being more responsive to government’s interests, but less likely to uphold independent policy decisions.
A similar issue is playing out in the US. Over the last couple of days, President Trump has turned up his criticism of the Chairman of the Federal Reserve as the said Chairman raised the benchmark interest rate for the fifth consecutive quarter. Press reports indicate that President Trump was so unhappy with the rate hike that he considered firing the Fed Chair – although it is not clear that he has the power to do so.
The governments may well be right in pushing for their agendas. Time will tell how the Indian or the US regulators respond to political pressures. But in the meantime, it is worth considering – as a recent OECD study reports – that the balance between due and undue influence is the central challenge of independent regulators.