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In the movie ‘3 Idiots’, the director of an engineering institute asks the students, “Who was the first person to step on the moon?” The students answered Neil Armstrong. He then asked “who was second?” Even before the students could answer, he said it does not matter as no one remembers who came second!
We can extend the analogy to the CEOs and MDs who are credited with success or blamed for the decline of organisations, but barely any attention is paid to their deputies.
Likewise, in the central banking world, it is the Governors who are remembered and not deputy governors. The crisis or success of monetary conditions is often attributed to the Governor with the name of the deputies never even mentioned.
Outgoing RBI deputy governor Viral Acharya did make efforts to change this hierarchy. He was not willing to play second fiddle to the Governor and built his own image.
His tenure started in January 2017 at a time when India was reeling under demonetisation. The early days were not that noticeable though he took up the important portfolio of monetary policy and economic research and also took up the cause of establishing public credit registry. Few had ideas that he was about to raise a storm in Indian economy.
The storm was raised in October 2018, when Acharya gave a speech which made most people -- including this author -- rub their eyes in disbelief. In his speech, Acharya openly criticised the Indian government for taking away the independence of the RBI. He cited the example of Argentina whose central bank has always been under pressure from the government only to invite ‘wrath from markets’. Comparison to the Argentinian central bank may have been far-fetched, but created the desired impact.
The speech opened a can of worms and led to a bitter squabble between the government and the RBI. Several issues such as the government eyeing a share of RBI’s reserves and using Section 10 of the RBI Act came to the fore. This was followed by the resignation of RBI Governor Urjit Patel in December 2018. For central bank watchers, it was not a question of whether Acharya will resign but when. Thus it was not surprising when he chose to resign in June, six months before completion of his 3-year term.
Whether one liked the speech or not, it will go into the annals of the history of central banking as one of the most aggressive defences of central bank independence. That too from a deputy governor! Most Governors would think twice giving a speech on central bank independence and those who do, choose softer words and tone.
The October speech was not the lone one. He chose to leave the RBI with another hard-hitting speech where he questions the high government borrowing and how it is creating investment problems for the private sector. The speech was earlier given at IIM Ahmedabad -- in which the author was present -- and later as Hormis Memorial Lecture organised by Federal Bank in memory of its founder K P Hormis.
In the lecture, he asked the following question: Does government borrowing crowd out the private sector in India and what are its ramifications? To buttress his point, he shows how India’s fiscal deficit is second highest among G-20 countries.
This is obviously surprising to the common man who often learns from the financial press that India continues to meet its fiscal deficit target which is low and this augurs well for Indian economy. However, the catch is we mostly report the deficit number of the Centre ignoring that of the state governments. If we include the latter, we are placed just next to Brazil which suddenly makes the Indian economy look more vulnerable than it is made out to be.
Acharya went on to argue that if extra government spending was done to meet its capital expenditure, it is still fine and welcome. But that is not the case as the share of capital expenditure in total expenditure has consistently been around 15 percent. Further, as domestic savings are mostly used to finance the deficit, the private sector is crowded out and becomes reliant on capital flows from abroad. These capital flows are fickle and easily exit markets when there is a rise in global uncertainties as seen in 2013. This makes private sector investment vulnerable to the global economy.
He spoke of three channels of crowding out. First is the real channel which says that when government borrowing increases, it leads to anticipation of higher taxes in future (called Ricardian equivalence). This leads the private sector to stop investing as they are likely to be taxed higher in future.
Second is bank lending channel where banks end up buying more government debt and do not lend to the private sector.
Third is corporate bond channel where financial companies such as mutual funds, insurance companies etc. begin to buy more government bonds compared to corporate bonds.
In the first channel, the private sector is not willing to invest and in the other two, it is not able to get funds for investment. In India, the bank credit channel is stronger than corporate bond channel. It also influences financial stability as corporates are forced to issue shorter-term bonds as the interest rates are high in the longer term.
Acharya also shows how crowding out is stronger when there are low foreign capital flows compared to the phase when it’s high. This also proves that when companies actually need more domestic savings as foreign inflows are weak, they are crowded out more.
The impact is even seen on interest rates. His research shows that when government debt rises by 1 percent, yields of AAA corporate debt rise by 2.3 percent, making it costlier for even the highest-rated firms. Monetary transmission is also stronger when share of government debt is below the median level.
His suggestion to the government is four-fold.
First, improve share of capital expenditure so that more spending is on public goods than meeting revenue expenditure of running the government.
Second, increase the share of disinvestment programme in the overall revenue, which will reduce borrowings and debt.
Third, establish an independent fiscal council that verifies the fiscal accounts and takes into account off-balance sheet borrowings which hide the true fiscal deficit.
Four, continue the emphasis on structural reforms on policy matters such as GST, the Bankruptcy code and on sectors such as labour and agriculture.
In the end analysis, the governments can bolster central banks by appointing capable deputies with an independent mind. This is evident from other geographies as well. Prominent examples include Guo Shuqing, deputy governor at the People’s Bank of China who gave a piece of his mind to the US government and Riksbank’s Cecilia Skingsley whose speeches have been useful in understanding digital currency. However, in today’s times, it is likely that governments want independent minded central bank officials as frictions have hit a new high or low, depending on which way you look at it.