Does this demonetisation drive undermine so called RBI independence?

I am surprised no one is asked this question yet.

History of two previous demons tell you that both the times, RBI chiefs had reservations about the idea. It still went through, as government is the final boss. The real fear for RBI was the move could destabilise the economy for what were perceived as fiscal and political goals. In 1946, RBI chief thought the exercise was aimed at increasing taxes and in 1978, he said it was on political grounds!

We really do not know what RBI views have been on a demonetisation exercise as big as this. In 1978, it juct knocked of 0.8% of currency and still RBI was worried. This time more than 100 times of the amount or 86% has been knocked off  and we do not know how central bank reacted to the initial idea. The key persons of RBI were involved in the secret planning (which has been inadequate to say the least) of the event. So, it is not as if they were kept off the loop. But since the whole thing was secretive, one does not know how much details will be shared when history of this period is written in future. This is as big a moment in India’s monetary history as any but may be we will never know,

However, one thing is really puzzling. How is it that the central bank has agreed to go ahead with this hammer of a tool to control/manage ills of the society (if one can call it that) at such a large scale? Did the Government completely ignore caution or warnings made by RBI on this matter? Or RBI just gave into Government’s demands?

All this is important as no one cared about central bank independence or autonomy in 1946 0r 1978 when last demonetisations were done. It matters a lot now. Perhaps it is the only thing that matters in debates around central bank – it should be independent. We all celebrated when the new RBI Governor was appointed using all kinds of adjectives and finally saying thank god, RBI will remain independent given the credentials of the new Governor!

Though, this blog has never really cared much for independence noise as one knows that the final call is that of the govt. But there are certain matters where central bank has to strongly oppose or warn even if it has no independence as earlier ones did. Now we think it has independence so one just hopes there is enough defense of the turf.

One is already seeing some signs of people questioning all this. In this piece, Ashok Swain says:

The decision of withdrawing Rs 500 and Rs 1000 notes in such an abrupt manner was Modi’s alone. Like many other important decisions of his government, on this one too he had not taken his acquiescent cabinet into confidence.  He even handpicked a pliant Reserve Bank of India governor to go along with him in his precarious choice.

Ila Pattnaik says this decision puts the recently constituted MPC into a puzzle:

There is a widespread sense that the decision of the government is bad news for bad people but for the rest we will be fine. This thinking may be too complacent. In the last few months, RBI, government, the newly constituted MPC and many observers have realized that demand in the Indian economy is weak and there is a need for monetary easing. 
In the decades before the policy rate was used for monetary policy, the main instrument of monetary policy used to be money supply. Now we have got a huge reduction in money supply. The timing of the monetary tightening is inconsistent with the stance of monetary easing. We expect that this sudden tightening will negatively impact production in the quarter Oct-Dec 2016. 

She does not question independence per se, but the MPC easing has created a really awkward situation. What does it do in next meeting?

Though, section of markets are believing it makes the case for rate cuts given slipping demand etc. I mean it is getting so bizarre. You ease with rates, then tighten the supply suddenly and then again ease rates as economy is not generating demand.


A good friend and regular follower Mumbai Paused told me someone did ask the question. RBI staff itself!


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