Stressing the need for more coordination between the central bank and the government, Chief Economic Adviser Arvind Subramanian Monday said that independence of a central bank is not only acquired through law but also by actions and good decision-making. A series of bad decisions, he said, can impact the credibility of a central bank.
The CEA’s statement comes days after RBI Governor Urjit Patel, in the wake of the fraud detected at the Punjab National Bank, pointed at the central bank’s helplessness in dealing with public sector banks due to constraints of inadequate legal powers to supervise and manage them.
Responding to queries from students of Jesus and Mary College in New Delhi as part of a lecture series, Subramanian said: “Independence is not acquired through the law but a large part is acquired through reputation and the history of good and effective decision-making. When you say a central bank has credibility, it gets credibility not just because it’s independent… After all, if you are independent and make a series of bad decisions, you lose credibility. So, what is important is not just what is there in the law but actual practice of a central bank.”
He said not only “independence but also coordination (is) very important. Second, what is more important than independence is your credibility and reputation, and you can get that either legally or you can acquire it through actual practice”.
Earlier this month, Urjit Patel had pointed to constraints in dealing with PSBs. Quoting the Detailed Assessment Report on the Basel Core Principles, he had said that the RBI cannot remove public sector banks’ directors or the management who are appointed by the government. Nor can it force a merger or trigger the liquidation of a state-owned bank, he said, underlining that it also had limited legal authority to hold public sector bank boards accountable regarding strategic direction, risk profiles, assessment of management, and compensation.
Seeking more powers, Patel had said legal reforms are highly desirable to empower the RBI to fully exercise the same responsibilities for PSBs that now apply to private banks, and to ensure a level-playing field in supervisory enforcement.
Citing the historical reason for making central banks independent, Subramanian said that countries around the world wanted to make policy independent of election cycles.
“The question is: do we need more independent institutions like RBI… when countries around the world started making central banks legally independent, it was because they thought the economic argument for doing that, because they thought that politicians make decisions related to the election cycle… So, they thought they need independence to avoid policy driven by political cycles. So, I think that was done.”
He said the emerging thought now is that central banks and governments need to cooperate more because the election cycle problems are not there anymore. “The other problem is that sometimes the central banks may have to do what governments can’t do. Example, the Fed and the European Central Bank, they put their balance sheets at risk to stimulate the economy. Now if you have a very traditional notion of what central banks should do, that would be considered actually not the right thing to do. In some ways, our thinking is evolving in terms of how much independence and how much coordination should be between the central bank and the government,” he said.
Subramanian also defended the multi-rate structure of Goods and Services Tax (GST), saying that a single rate of say 10 or 15 per cent will result in goods meant for poor also getting taxed at the same rate.
“Under the old system and under the new system, lots of commodities, about 50-60 per cent of the basket consumed by poor is exempted from the GST. So, essentially we have tried to protect the poor. But remember, this creates the challenge, there are some like you who say it’s a regressive tax, but there are others who say — we must have a simple system, we must have one rate… if you have one rate and have a 10 or 15 per cent tax and then commodities consumed by the poor will also be taxed at 10 per cent. So, the political compromises. And therefore, you need either a zero-rate or a very low rate for commodities predominantly consumed by poorer people. By and large, food is exempt, health, education are exempt,” he said.
He said that from a development perspective, the country needs to have more income taxes and direct taxes. “I think one of India’s big challenges is how do we get more and more people pay income taxes. I think that’s very critical, and we are really falling short on that. Any direct tax system must encourage voluntary compliance to get more and more taxpayers in, and this is something we should be focusing on,” he said.