Why should the government own the RBI?

Back in 2015, it may be recalled, everyone was getting very excited about Raghuram Rajan, Reserve Bank of India (RBI) governor, and the government. M G Warrier, an old RBI hand, had commented thus: 

“There have been unending disputes about whether the curd is dependent on the pot for its existence or whether the pot gets value addition because it contains the curd (Thakrasyaadhaaram Ghatam vaa Ghatasyaadhaaram Thakram?)” 

I don’t think we will ever know. But that is probably why friction is inherent in the relationship and flares up from time to time. And that brings me to three questions I have been asking for the last five years.

The first is why the government should own the RBI. The second is if it is ok for it to do so, why complain when it cracks the whip? After all, you can’t have it both ways. 

Whence my third question: Why should the RBI not be re-privatised? Think about it: What virtue is there in it belonging, lock, stock and barrel to the government? The Bank of England, even though its wings went on being clipped, managed perfectly well in private hands from 1694 to 1946.

But having handed the hencoop to the fox, in India, in recent years, in order to keep the RBI relatively free from government control, two methods have been adopted. 

One was to vest the governor with virtually dictatorial powers but remind him from time to time who the boss was. Thus, without realising it, successive Indian governments adopted the solution suggested by two economists —Mark Satterthwaite and Alan Gibbard. They had tried to solve the problem of decision-making in committee in which members indulged in tactical voting, that is, the sort of voting that creates a problem called inefficiency in information aggregation. This happens because not all committees that aggregate information do so efficiently. There is also the problem of conflict of interest in committees, about which a lot has been written in recent months. 

For some reason best-known to him only, Mr Rajan divested himself of this dictatorial power and decided to entrust the determination of the price of money — the interest rate — to a committee, half of whose members were appointed by the government. In this manner the problem of tactical voting got accentuated.

The result is that no one knows any longer whether he/she is coming or going.

There are three ways of solving this problem. One is to dissolve the Monetary Policy Committee and go back to the “governor is king” principle. The other is the one suggested in 1785 by Marquis de Condorcet, who said the larger the number of members in a committee, the higher were the chances of it reaching a correct decision and, further, with an infinite number of members, the probability of a correct decision was one. So if we want to get the price of money right, the MPC should have 1,000 members. Or we should reconcile ourselves to getting it wrong.

The third is the one I have been proposing: Reprivatise the RBI. There is absolutely no reason why we should think that a privately-owned central bank, or a board with private shareholders, will reach more wrong decisions than a government-owned central bank or a board that is stuffed with government appointees. The evidence of the last 60 years is quite to the contrary.

The point is this: When it comes to borrowing, governments behave exactly like any private citizen. They want the lowest rate possible. Since governments are also the biggest borrowers by a huge margin, if they own the central bank they make sure that interest rates stay lower than aggregate capital availability would permit. 

That is, the price of money is more often wrong than right. And, when the price of money is wrong, everything else also goes out of kilter. That’s the price we pay for a nationalised central bank.

You may well ask what guarantee is there that a privately-owned central bank will get the price of money right. But that is the wrong question. The correct question is how often it will go wrong if it is not owned by the biggest borrower in the country.

To find out you should read the history of the Bank of England. You will see that until it was fully nationalised, it did a remarkable job. After that, well, we know what happened, don’t we?

Anyway, no one is going to buy this idea, but someone should, I think, in the interests of academic enquiry, commission a three-year project to examine the implications of re-privatising the RBI, to be led by Mr Rajan and Urjit Patel.

Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel