Understanding RBI Board’s role in Demonetisation 2016…

This is a great time to learn about role of law in monetary affairs. It is so crucial as we will see.

One question that is central to the demonetisation strike is “What gives government the powers to declare legal tender illegal?”

These powers come from RBI Act. Not surprisingly, the act was made by the British government and we have just followed! They ensured that amidst all this legal language which shows an independent central bank, the power to make a currency legitimate or illegitimate remains with the government.

Section 26 (2) of RBI Act gives these powers:

(2) On recommendation of the Central Board the [Central Government] may, by notification in the Gazette of India, declare that, with effect from such date as may be specified in the notification, any series of bank notes of any denomination shall cease to be legal tender 2[save at such office or agency of the Bank and to such extent as may be specified in the notification]. 

It says on recommendation of the Central Board government may declare a currency as illegal tender by issuing a notification in the Gazette of India.Why Gazette? Well it contains all the notices of the government. One can see the Gazette notification on 8 Nov 2016 here and here.

If you notice it says “On recommendation of the Central Board….” this can be done. What is the Central Board? It is the main body of RBI which governs the central bank and has 21 members . These directors are divided into official and non-official:

  • Official Directors
    • Full-time : Governor and not more than four Deputy Governors (which means 5 members)
  • Non-Official Directors
    • Nominated by Government: ten Directors from various fields and two government Official (10 + 2)
    • Others: four Directors – one each from four local boards (4)

Local boards represent the four zones – North South East and West. Each of these boards have 5 members nominated by the government. Each of these local boards nominate 1 from the 5 members to the  Central Board by themselves. This whole thing is to give that regional diversity. So, we have some regional diversity at Central board level but not at MPC level.

So, all major decisions happen through the Central board. Section 13 of the Act says:

(1) Meetings of the Central Board shall be convened by the Governor at least six times in each year and at least once in each quarter.
(2) Any [four Directors] may require the Governor to convene a meeting of the Central Board at any time and the Governor shall forthwith convene a meeting accordingly.
(3) The Governor, or [if for any reason, he is unable to attend,] the Deputy Governor authorized by the Governor under the proviso to subsection (3) of section 8 to vote for him, shall preside at meetings of the Central Board, and, in the event of an equality of votes, shall have a second or casting vote.

The last meeting was held in Kanpur on Oct 20, 2016.

Now, if one looks at the current board members, we just have 10 members:

  • Official Directors
    • Full-time :1 Governor and 3 Deputy Governors (there are 4 instead of 5)
  • Non-Official Directors
    • Nominated by Government: 3 Directors from various fields (there should be 10) and 2 government Official (2 should be there)
    • Others: 1 Director  from four local boards (there should be 4)

It is interesting that barring government officials, all other categories have vacancies. Out of 10 directors from different fields, we have only 3 filled positions. At local board level there is just 1 representation from the Eastern zone (where banking penetration is weakest). We still have bot filled one Deputy Gov position after one of them took over as Governor.

One is not sure how effective the Central Board is in RBI as there is hardly any discussion on this matter. Most attention remains on the official directors and the governor.

But in this case, Central Board played a crucial role as demonetisation happened on their recommendation. That is what law says as per Section 26 (2) of RBI Act. Again repeating it:

(2) On recommendation of the Central Board the [Central Government] may, by notification in the Gazette of India, declare that, with effect from such date as may be specified in the notification, any series of bank notes of any denomination shall cease to be legal tender…

I mean the whole exercise is so confusing. One knows that just 2 persons from RBI (Governor and 1 DG) knew of the exercise. They were part of the Central Board but not the board. The Full Board as we know was informed by the government at 6 PM on 8 Nov 2016. So one can say: “The Central Board based on government orders recommended the government to declare that Rs 500 and Rs 1000 currency have ceased to be legal tender….”.

But the Board is barely full. Infact it is less than 50%.  It is highly understaffed and has been there for a while. People have raised concerns on this (one in 2015 and two in 2016). One would imagine a decision of such momentum is atleast placed before a fully staffed Central Board. But as the RBI Act does not say anything on the number of Board members required to pass such notification, it was just done in this way.

Previous two denominations were via ordinances and did not require RBI Board recommendation as government ceased them via fiat. This time also it was fiat but in a round about way.

Given eerie silence of RBI executive members, one was wondering whether we have any views from the non-executive non-government officials on the move. This position is seen as a fairly prestigious one as well and has been occupied by who’s who of corporate and policy world. One just hopes they had enough time to atleast express their views on the policy.

All these recent events continue to poke holes at the independent RBI noise which has been played for a while now. At the end, all important and momentous monetary policies are basically run from Delhi. The RBI Act is being amended to look at inflation targeting etc which looks way too superficial given the recent spate of events..

9 Responses to “Understanding RBI Board’s role in Demonetisation 2016…”

  1. Kimi Says:

    Outstanding coverage. Thank you

  2. MS Says:

    Yes excellent coverage Amol, thanks for diving deep for all of us !

    As a layman, I have a big question: this so-called ‘independence of central bank’ seems a bit axiomatic. I read some of your related entries where you point out what the reality is in India, but I do not find some justification for why the central bank NEEDS to be independent.

    Mind explaining this in an entry some time ? Thanks

    • Amol Agrawal Says:

      Hi MS.. Well firstly central bank independence is a very strong word. It should be central bank autonomy where we say given a broad goal, the management is autonomous towards pursuing it. This is the case for most government organisations and same with central bank as well.

      However, in case of central banks things are slightly different. As they are the agency for managing currency notes, the government has special interests in the organisation. This leads to the usual differences between government and central bank on what is right and what is wrong.

      The final call on all matters is that of Government. Whatever autonomy a central bank gets is dependent on the govt. We have seen in this decision how the government can completely take away the monetary function from you. So no matter how much you say you are independent, the government knows all is under its control.

  3. Public haranguing by politicians has become a tool to undermine central bank autonomy - TOI Blogs Says:

    […] In India, Prime Minister Narnt on the evening of 8th November about the withdrawal of legal tender nature of high denomination currency notes has triggered a chain of events which have once again raised questions about RBI’s level of autonomy. […]

  4. Mohan Says:

    Hi Amol, thanks for your detailed work here and some very valid questions. However, I wanted to point out that in the board meeting on the 19th of May, they discussed about the designs of the new banknotes (check out the RBI press release), so it is conceivable that the board did discuss about withdrawal as well. And it is understandable if the press release doesn’t talk about withdrawal given the sensitivity of disclosure.

    Although I agree the governor should have at least communicated with the public, that is a big contrast with Rajan. He is leaving all the explaining to Modi, maybe that is astute for him personally, but not for the RBI’s perceptions of independence or otherwise.

  5. Amol Agrawal Says:

    Hi Mohan. Thanks a lot for the comments. Well, Govt says the entire operation was known to a very few people and was top secret. So don’t see Board discussing it. This is just unprecedented at lot of levels.

    Also astuteness should have been shown at the time RBI top brass was informed of the move. Now there is no time to show it. There are some other articles questioning the RBI independence on the matter as well.

  6. A closer look at the Fed’s Balance Sheet accounting (applies to other central banks as well)… - Daily Economic Buzz Says:

    […] from economics which are vital to understanding monetary policy: law and accounting. We have seen importance of law in India’s demonetisation and even advent of digital currency which has made us look at terms like legal tender, currency […]

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