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India -- retreat of liberal economics

New central bank chief will likely bring less independence and more obedience to Modi's policy demands

| India

Worldwide, central banks are under pressure from governments, but the most striking instance is the change of the guard at the top of the Reserve Bank of India, where Urjit Patel has quit in dramatic fashion and been replaced by Shaktikanta Das, a loyal government bureaucrat.

We have seen this movie before in emerging economies from Argentina to Turkey, and it never ends well. A U.S.-educated economist with international stature and global business experience has been replaced by a non-economist, a retired civil servant who dedicated over three decades of his life to the Indian bureaucracy and is now more than likely to do the government's bidding.

His best-known achievement so far has been to oversee demonetization -- the botched 2016 cancellation of high-value currency notes in a futile bid to fight corruption, that Prime Minister Narendra Modi insisted was necessary even though most economists said in advance it would be a disaster.

Patel's sudden departure on Dec. 10 follows months of intensifying tension between the central bank and the government, with ministers all but pressing the governor to loosen monetary policy, hand over hundreds of millions of dollars in "excess" reserves, and relax stringent rules which prohibit public sector banks, saddled with bad loans, from further lending.

Indeed, it is exactly the fact that Patel pushed back against government encroachment on the central bank's functional autonomy, and the government's intransigence in attempting to have its way, that precipitated the current crisis, and Patel's replacement with a successor who ministers clearly believe will be more pliant.

It is not hard to fathom the motivations of Modi and his government. He is heading into a tough re-election campaign -- national elections must be called by May 2019 -- in the context of a weakening economy, and lackluster jobs numbers. The scale of the challenge has just become even more apparent with the ruling Bharatiya Janata Party suffering heavy losses in five state elections where the results have just been counted.

So, Modi wants to pull out all the stops of fiscal, monetary and regulatory policy to ramp up the economy and win a second term in office, something that no party other than the venerable Indian National Congress (now in opposition) has managed since independence in 1947.

The short-term motivation of the government runs up against the prudence and long-view approach of the central bank. This is a standard rationale in economics for granting central banks considerable autonomy from political interference. It applies in India as it does elsewhere.

But there is more than textbook political economics at play. Increasingly, it has become clear that Modi's rhetorical commitment to free market economics -- captured in his commitment to "maximum governance, minimum government" in the 2014 election campaign which saw him and his BJP win in a landslide -- was little more than good marketing.

The reality has been a government more meddlesome in the economy than many in the recent past. Among other poor policy choices, the government has reversed a quarter-century trend of trade liberalization, to raise tariffs sharply across a range of sectors, with the vain hope of revitalizing a moribund "Make in India" campaign. The return to import substitution, a failed policy abandoned with the 1991 economic reforms, reeks of desperation.

The protectionist swing follows the earlier demonetization fiasco and the mismanaged introduction of a new national sales tax. Ironically, it was Das, the newly appointed central bank chief, who supervised not only demonetization but also the tax reform.

Despite campaigning on a small-government ticket, schemes and programs have ballooned on Modi's watch, including a recently launched and ambitious (near) universal health care scheme, popularly known as "Modicare." If fully funded, this will break the exchequer, even without accomplishing its stated goals of improving health care for the neediest Indians.

But the most disturbing trend is not a drift away from good economics toward familiar forms of populism, but the rise of a homegrown brand of unorthodox economics variously known as "Indic" or "Hindu" economics.

The canary in the coal mine was the recent appointment of Swaminathan Gurumurthy, a firebrand, right-wing, self-styled economist (he is a chartered account by profession), to the central board of the RBI. Widely reckoned to be the brains behind demonetization, Gurumurthy is not merely an old-fashioned protectionist who dresses up his views in a cultural garb, but an advocate for delinking India from the globalized economy. He is but the most visible of a large lobby who hold similar, retrograde views.

A return to autarky, or even a movement back toward it, would be disastrous for India, and would spell the end of any prospects of sustaining the current economic growth of around 7%, let alone achieving double-digit growth, which the country sorely needs to lift millions out of poverty and create more gainful employment.

The acolytes of Indic economics espouse an end to free trade and free movement of capital. Nor are they interested in the free flow of ideas. For many of them, all relevant knowledge, on economics and policy as well as other subjects, existed in India in ancient times. They seek to reduce the influence of successive generations of "foreigners" -- meaning non-Hindus -- who have altered India's putative original purity.

Patel's exit from the RBI is not only a significant chapter in the checkered history of global central banking, but also a grim development in the decline of liberal economics in Modi's India.

Vivek Dehejia is a professor of economics and philosophy at Carleton University in Ottawa, Canada.

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