Gurumurthy’s Bad-Cop Role May Have Helped Push Government And RBI Towards Compromise 

Why did the finance ministry and the Reserve Bank of India (RBI) smoke the peace pipe at Monday’s nine-hour-long meeting of the RBI board? Why did both sides back down, the RBI more than the government, when fireworks were expected?

The simplest explanation may lie in the possibility that both the parties saw needless institutional damage in pursuing their feud to the finish, but one can speculate that a good-cop-bad-cop routine may have played its part in defusing the crisis.

According to a Times of India report today (21 November), several independent directors on the RBI board worked behind the scenes to stake out compromise solutions on the key sticking points, and they obviously played the good cops. Good cops can deliver best when there is the possibility of a bad cop threatening mayhem. That bad cop could well have been the irrepressible Swaminathan Gurumurthy, the government’s unexpected appointment to the RBI board in August.

Now, Gurumurthy is a chartered accountant, and not an economist. In fact, his views on economics often tend to be maverick, as he tends to question western orthodoxies in several areas. He tends to rubbish conventional views on economics as hangovers from a colonised mindset, where theories developed in a western context are blindly applied to the Indian economy without making allowances for the nature of our society here.

In the run-up to the RBI board meeting, Gurumurthy was belligerent in his demands for loosening the corset around weak banks, improving the flow of credit to the MSME (micro, small and medium enterprises) sector, and demanding an amendment to the Fiscal Responsibility and Budget Management Act (FRBM) so that we can finance more through deficits (read here, here, here).

He chafed at the bit when noting that America could do any kind of currency printing and get away with it, but not India. He said in a recent speech: “America printed $4.5 trillion between 2008 and 2014. They issued digital currency and saved the local economy, funded the global economy and no one said the US. Fed was wrong in doing it. But if any other country had done it, they would say it will die of inflation.” (Read the full text of Gurumurthy’s speech here).

He also pointed out that Japan prints billions of yen to lift its own economy out of the ditch. It has been printing $40 billion worth of yen every month since October 2015, and this printing has only increased. India, he says, has needlessly given up this right to print money when needed by imposing restrictions on itself through the FRBM Act.

The practical flaw in Gurumurthy’s argument is obvious: America can get away with fiscal indiscipline because its currency, the dollar, is a safe haven for investors, and it is also the largest economy in the world, which buys the largest chunk of global goods and services. Thus, American fiscal profligacy does not cost the economy much in terms of capital outflows. The world needs America more than America needs it – at least in the medium term.

In the case of Japan, most of its borrowing is in local currency, and given high domestic savings rates and an ageing population in an already wealthy country, there is practically no cost to this money printing (ie, borrowing at near zero costs from savers).

Neither the US nor Japanese situation applies to India, for Indian government borrowing has real costs. And in the case of India as in many emerging economies, at the first sign of fiscal distress, foreign capital will flee, causing a drop in the rupee and also damaging the stock market.

The important elements in Gurumurthy’s arguments though are not these, but his broader point that monetary arguments that work for the west may not necessarily be applicable to India. And tight money policies ought to be appropriate to the situation at hand, when demonetisation and the goods and service tax (GST) have impacted the MSME sector more than the rest, and hence in need of special treatment.

The key benefit of having Gurumurthy and his unorthodox views on the RBI board is that it is no longer possible for the Governor to ignore the board, and his very existence may force the RBI to be more accommodating when independent members try to work out a middle path.

Whether by accident or design, the insertion of Gurumurthy into the board has activated a good-cop-bad-cop situation in the government-RBI relationship, and it is doing some good. Neither government nor RBI should, however, push their luck too far. At some point, they need to talk without the board as peacemaker and Gurumurthy as flamethrower.