The Hindu Business Line : Analysing seventy years of central banking

The RBI has attempted the difficult task of analysing and presenting the 70 years of its existence in the backdrop of development of central banking worldwide. The report swings from the simple to the abstruse. This is a problem with attempting to bridge the two worlds of practical experience and academic excellence. But the RBI must be congratulated for attempting a difficult task.

REPORT ON CURRENCY AND FINANCE

The Reserve Bank of India's latest Report on Currency and Finance continues the tradition started in 1998-99, of focussing each year's report on a theme. This report is unique inasmuch as it attempts to analyse and present the RBI's last 70 years in the backdrop of development of central banking worldwide. Admittedly, the task is difficult. Against this, the central bank's heroic effort is competent and clearly structured.

One is used to the standard style of review of macroeconomic developments in the annual Survey of Currency and Finance. All that is presented in the latest report as a chapter. The primary emphasis is, however, on the theme of evolution of central banking. I must confess that while the presentation is competently done, it may not satisfy the criteria of academic excellence, in view of its attempt to keep the presentation simple. At the same time, some portions of the exercise are too abstruse for the lay reader. This is a problem with attempting to bridge the two worlds of practical experience and academic excellence. But the RBI must be congratulated for attempting a difficult task.

INSTRUCTIVE HISTORY

While the history of evolution of the RBI over the last 70 years is, indeed, instructive, I am particularly impressed by the chapters devoted to the monetary fiscal interface, the balance-sheet and the organisational evolution and strategic planning in the RBI. On the question of the monetary fiscal interface, the report addresses the critical issues of central bank support to the governmental fiscal gap. It traces the history of such contribution, placing it in the context of historical developments. In the context of planning in India, the RBI got further drawn into financing the fiscal gap. It also assumed a developmental role. The report narrates the evolution of RBI's support to government from its inception through post-reform days when its support was phased out.

The elimination of the arrangement of ad hoc Treasury Bills, a peculiarly Indian innovation, was symptomatic of the reforms in the monetary-fiscal interface. The passing of the FRBM Act with its restrictions on RBI financing the government is a logical culmination of this trend. This has naturally resulted in increase in bond financing — the government having resort to floating bonds in the market.

REPURCUSSIONS ON FINANCE

This has its repercussions on availability and cost of finance for the private sector. The issue of bond financing versus money financing of Government departments has been adequately dealt with by the RBI in an earlier report.

But a brief reference to the debate would have been appropriate in the latest report also. The report addresses the issue of separation of the debt management function from the monetary authority role of the RBI.

While the arguments in favour of such a separation rest on the perceived conflicts of interest between the two functions, the report does point out that the best way may be to hive off the debt management unit from the RBI and place it in the government.

But that does not fully remove the problem of coordination between the two units. It does not introduce total neutrality in the debt management role.

The monetary authority will still continue to have knowledge of the fiscal problems and will be influenced in some manner or other by the need of government to have a lower cost of borrowing. The separation of roles is, however, fashionable. So, one can only wish the best of luck to the debt management function in its new avatar.

The latest report devotes a special section to the questions relating to the evolution of the balance sheet of the RBI. It refers briefly to the question of adequacy of capital of RBI, considering its large asset base. The equity of the RBI is rather small at present. Hopefully, some Basel-II type norms will apply to the RBI itself.

The Government will have to adequately raise the capital it has invested in the RBI from the current measly figure. The discussion on balance-sheet touches on other weighty issues, such as the distribution of surplus to government and the size of the contingency reserves. It points out the varying practices in distribution of surplus to governments in different countries.

Anyway, the practice in India has settled around a reasonable level of contribution of surplus from the RBI, although it is limited by the extent of diversion to contingency reserves. The RBI report points to various practices in other banks, which come down in favour of caution — meaning the level of contingency reserves should be adequate in relation to the size of assets and the liabilities. Status quo is favoured obviously.

STRATEGIC PLANNING

The latest Report on Currency and Finance devotes a chapter to the evolution of strategic planning in the RBI. I was privileged to be in the RBI when the first effort was initiated in 1992. It is significant that in other central banks, the strategic planning effort is taken up once in four or five years. It is a pity that the effort has been discontinued in the RBI.

The RBI will gain by undertaking a renewed effort on strategic planning at periodic intervals, so as to update its vision and review its strengths and weaknesses.

The human relations aspect of the RBI's development do get some attention in the report. It has been improved considerably during recent years. But, the need for attending to training, motivation and, in particular, initiatives for the technical personnel who run RBI cannot be overstressed.

The continuing emphasis on technology upgradation is also an important part of the march of the RBI towards excellence.

This necessitates an enhanced emphasis on recruitment of highly trained staff at the entry levels to at least a limited proportion of the strength of the RBI. Only then, will the RBI be able to meet the requirements of the new age of IT-enabled financial services.

ROLE IN ECONOMY

The latest Report on Currency and Finance is a welcome addition to the series of reports produced by the RBI from time to time. It will surely spur debate on the role and effectiveness of monetary policy and in that context the RBI's role in the economy.

One issue I find missing in the effort is the need for restructuring the corporate governance of the RBI itself with a view to involving various regional and sectional interests in its Board.

Perhaps, an attempt at copying the best features of the federal structure of the US Federal Reserve will enable the RBI be more responsive to the changing trends in the economy. What I specifically imply is that there is need to rethink the present corporation vision of the RBI and substitute the present organisation by a federal structure of suitably empowered regional boards, which are more effective than the present ones.

The Regional Boards should be more like the regional counterparts in the US Federal Reserve with representative authority and influence adequate to handle local problems.

What is important is to initiate a process of thinking on likely changes that will be needed to make RBI a more flexible and responsive institution to meet the changing needs of a vast country with different needs in diverse regions.

There is imperative need to initiate a process of reinventing the RBI for the 21st century.

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