Time for RBI to speak up

A lot has changed at the Reserve Bank of India in the aftermath of the historic and unprecedented move to withdraw Rs.500 and Rs.1000 denomination currency notes. Rarely in recent history has this 80-year-old institution been in the headlines almost daily, with questions, doubts and clarifications being sought by a harried citizenry and answers flowing only in fits and starts, more to cross a new hurdle or fix a creeping problem rather than as a cogent policy announcement.

The remark by the former Prime Minister Dr. Manmohan Singh that the repeated twists, tweaks and changes in policy do not reflect well on the RBI is only a mild rap for an institution that has otherwise stood out as a pillar of integrity – steadfast in its mission, protective of its independence and largely uninfluenced by extraneous considerations when dispensing advice.

It is the mandate and the responsibility of the RBI to manage the transition. Currency and liquidity management are core central banking functions, and the onus is on the RBI to make the transition smooth and painless. As evidence suggests, this is clearly lacking. RBI cannot take the shelter of ‘secrecy’ to justify such a poor transition.

It is not that the RBI must take the blame for the decision to withdraw as much as 86 per cent of currency notes though strictly speaking the government could not have done this without a formal and prior recommendation of the RBI board under Section 24(2) of the RBI Act.

It is important to note that the government has only one role to play, that is the announcement of the withdrawal. Thereafter, the RBI has a greater challenge to handle the logistics management in terms of printing and distributing the new currency, destroying the old currency and on the top of it managing the rupee liquidity and ensuring the appropriate short term interest rate through changes in policy repo rate.

It is the mandate and the responsibility of the RBI to manage the transition. Currency and liquidity management are core central banking functions, and the onus is on the RBI to make the transition smooth and painless. As evidence suggests, this is clearly lacking. RBI cannot take the shelter of ‘secrecy’ to justify such a poor transition.

It is interesting as well as instructive to study the currency management architecture (CMA) of the RBI, which is entrusted with the function of note issue and currency management by the preamble to the RBI Act, 1934, and by the specific provisions of Section 3 of the Act. RBI is the sole currency authority under Section 22 for the issue of bank notes. Section 23 right up to section 29 of the Act entrust the RBI with the power to decide denomination, forms and specify the legal tender status or the withdrawal of such status of bank notes.

Drawing from the colonial past, the initial years following independence were characterised by an exchange rate anchor set by the proportional reserve system prescribed by the RBI Act under which at least 40 per cent of the total note issue was to be backed by gold bullion and sterling. The proportional reserve system gave way to the minimum reserve system in 1957 (only Rs.2 billion worth of foreign securities and bullion needed to be maintained as a backing for currency issue, of which Rs.1.15 billion had to be in gold).

The RBI’s Currency Management Architecture comprises 19 issue offices, 4,075 currency chests (including sub-treasury offices and a currency chest of the Reserve Bank in Kochi) and 3,746 small coin depots at commercial, cooperative and regional rural banks, across India.

In the absence of proactive handling, the biggest loss of all therefore is the loss of voice of the RBI – the one institution that should be in the forefront, addressing concerns and managing expectations day in and day out. The independent voice of the RBI is an asset and it will be gone if the RBI does not boldly speak out on matters it must.

The Reserve Bank places an indent for banknotes with printing presses on the basis of an econometric model factoring in inter alia, real GDP growth prospects, rate of inflation and denomination-wise disposal rate of soiled notes. During fiscal 2015-16, the RBI supplied around over five billion pieces of both Rs. 1000(4.291 billion pieces) and Rs. 500( 0.977 billion pieces). The total expenditure on security printing was Rs. 34.2 billion.

This time, it is in a war zone. No model works.  Printing has of course to be round the clock and it still remains a race against the clock. Meanwhile, deposits are surging and reports indicate that over 90 per cent if not all of the notes of Rs.500 and Rs.1000 will come back.

If this happens, it essentially means that the entire plan to withdraw what the government has called high denomination notes will end in a monumental failure. A high price would have been paid in terms of the inconvenience to people, the pressure on banks, the loss of wages for the poor, a possible impact on rabi sowing, possible delayed business investments and incalculable second order effects which we cannot even begin to estimate at this stage.

Certainly, the warning by Dr. Manmohan Singh that the GDP could drop by as much as two percentage points, is cause for serious worry. This is not to calculate the cost to the banking system in terms of the lack of trust in the system this action can breed.

But while the government takes the rap for the larger decision, the RBI must not escape its share of the responsibility. It cannot be a voiceless tool in the hands of the government and must come out to speak more boldly, clearly and transparently. When the definitive history of the RBI is written, it is not the television debates but an analysis and learnings from this massive change that will be required to be recorded for future policy makers. One does not know if some internal reports or observations are being recorded systematically at this stage.

In the absence of proactive handling, the biggest loss of all therefore is the loss of voice of the RBI – the one institution that should be in the forefront, addressing concerns and managing expectations day in and day out. The independent voice of the RBI is an asset and it will be gone if the RBI does not boldly speak out on matters it must.

Essentially, the RBI wants to take the nation to a cashless economy of today but is itself stuck in the policy of the 1930s, when (to quote former RBI Governor D Subbarao), the wisdom was: “If you can’t say anything nice, don’t say anything at all.” In the modern day and age, what works is different. As Subbarao put it: “…greater transparency, active outreach and more open communication are positive for central banks; the impact, of course is more dramatic during crisis times.”

(Dr. R K Pattnaik is Professor, SPJIMR. Jagdish Rattanani is Editor, SPJIMR. Views are personal)