The Big Reverse

by Meera Sanyal

  With a significant treasury, consumer, corporate banking, diamond financing, and microfinance franchise, ABN AMRO, and later RBS Bank, in India was a systemically important foreign bank. We also ran the global back office, processing transactions for both RBS and ABN AMRO. My team and I, therefore, spent many hours at the RBI working with key officials.1

  These interactions gave me an opportunity to observe at close quarters the professionalism of RBI officials at every level. As a participant on several RBI committees, I saw the meticulous detail of scenario planning exercises, the thoughtfulness with which committees deliberated key monetary policy and economic issues, and the transparency with which data was shared and decisions were made.

  In September 2013, I went to bid Governor Subbarao farewell. We had enjoyed a very cordial relationship. Financial inclusion was a subject very close to his heart. In addition to discussing issues related to banking, I often met him to share learnings and experiences from my journeys to the villages. When he had been appointed, given his background in the Ministry of Finance, many had thought that he would find it difficult to take an independent stand against the ministry. I shared this with him. He laughed merrily and said, ‘Meera, maybe that’s what many people initially thought. But the RBI is not about any one man. Many excellent colleagues have supported my decisions. The RBI is an upright, independent and magnificent institution – we make our decisions in the best interests of the country.’

  As the demonetization saga unfolded, people began to ask on whose advice the Prime Minister had made this major decision.

  The Finance Minister, the Chief Economic Advisor, the Vice Chairman of NITI Aayog,2 all had been very silent during the initial days of demonetization. Their obvious discomfort in answering media questions led to rumours that none of them had been consulted about the move.

  However, it was the silence of the RBI Governor, Urjit Patel, that raised the most concern.

  In the weeks after the demonetization announcement, questions were repeatedly raised by the public, the media, the Supreme Court, and Parliament’s Public Accounts Committee3 (PAC), as to how the RBI, as the custodian of the Indian currency, had failed to ensure the country’s monetary stability.

  The PAC raised 10 very simple questions.4

  Union Minister Piyush Goyal has said on the floor of the House that the decision to demonetize was taken by the RBI and its Board. The government merely acted upon this advice. Do you concur?

  If the decision was indeed RBI’s, then when exactly did the RBI decide that it was in India’s best interests to demonetize currency?

  What was the exact rationale laid out by the RBI for this decision to invalidate `500 and `1,000 notes overnight?

  RBI’s own estimates show fake/counterfeit currency to be a mere `500 crore. India’s cash to GDP was 12 per cent, lower than that of Japan (18 per cent) and Switzerland (13 per cent). High denomination notes as a share of currency was 86 per cent in India, but 90 per cent in China and 81 per cent in the US. So, what was so alarming that the RBI decided India needed to demonetize suddenly?

  When was the notice sent to the RBI board members calling for an emergency meeting on 8 November? Which of them attended this meeting? How long did the meeting last? And where are the minutes of this meeting?

  In the subsequent note sent to the Cabinet recommending demonetization, did the RBI explicitly mention that this decision would mean invalidating 86 per cent of the country’s currency and its attendant cost? How long did the RBI say it would take to remonetize?

  The RBI notification of 8 November 2016 under Section 3 c(v) issued a restriction on withdrawal from a bank account over the counter to `10,000 per day and `20,000 per week. There was a similar limit of `2,000 per day in an ATM. Under what law and powers of the RBI were these limitations imposed on people to withdraw their own cash? What gave the powers to the RBI to ration currency notes in the country? If there are no laws that you can cite, why should you not be prosecuted and removed for abuse of power of office?

  Why have there been so many flip-flops in RBI regulations over the past two months? Please give us the name of the RBI officer who came up with the idea to ink people for withdrawal? Who drafted the notification on marriage-related withdrawal? If it was not the RBI that drafted these but the government, is the RBI now a department of the Ministry of Finance?

  How much exactly was demonetized and how much has been deposited back in old currency? What was the expectation of notes to be extinguished when the RBI advised the government to demonetize on 8 November?

  Why has the RBI refused to reveal information under the Right to Information (RTI), citing inane reasons such as fear of personal injury? Why is the RBI not providing information under RTI to queries that come?

  These questions reflected very poorly both on the central bank and Governor Patel.

  So did the erratic decisions and frequent about-turns of policy decisions by the RBI. No less than 68 circulars were issued during the demonetization period by the RBI,5 many of them contradictory.

  What were the pressures brought to bear on an upright institution and its Governor that led to such a fall from grace, and the RBI, once a respected and revered institution, began to be mocked as the Reverse Bank of India?

  Unfortunately, no answers were forthcoming and the silence was perhaps more eloquent than words. To unravel this mystery, it may be helpful to address a few questions.

  When Did Planning Start for Demonetization?

  In his speech in Goa on 13 November, the Prime Minister had stated, ‘I constituted a small team 10 months ago to execute a big operation. It was a humongous task, to print currency notes, distributing them to different banks. [We] had to keep it under wraps very carefully because the corrupt have strong sources within the government. If the information got leaked, they would have settled their accounts.’

  This implies, or should imply, that planning for demonetization had started in January 2016.

  From information in the public domain, we know that in April 2016, Raghuram G. Rajan, Governor of the RBI,6 had voiced his concerns on the ‘high year-on-year rise in currency in circulation in fiscal 2016.’ He surmised that this could be because ‘cash with the public goes up close to polls. You can see that there is a spike not just in the state going to polls but also in the neighbouring state.’ Rajan’s inference was possibly indicating that political parties were hoarding cash to woo voters in the major state legislature elections scheduled for 2017.7

  The State Bank of India’s (SBI) Chief Economist, Soumya Kanti Ghosh, however, presented a counter argument. In his report published in SBI’s Ecowrap of March 2016, Ghosh stated, ‘The common perception is that, FY17 being an election year, people are hoarding cash. However, had this been true, even FY14 should have shown the similar trend. In fact, that year witnessed a decline… the bigger reason, could be the trend in demonetization. There are suggestions in public domain and even analysis that are suggesting that higher denomination notes may be replaced. We believe, as a result of that, people may be using more of high value currency to purchase safe haven assets.’

  This was the first public reference to a possible demonetization.

  In the April 2016 issue of the same publication, Ghosh elaborated on this topic further, stating: ‘Demonetization, if is being contemplated, a road map needs to be created. It needs to be done in steps and be balanced with creation of necessary electronic and digital infrastructure in the country coupled with creating awareness and financial literacy for ensuring that the man on the street is not put to undue hardship.’

  The SBI Ecowrap report of April 2016, attached as Appendix 2, is the only document that has appeared in the public domain mentioning demonetization prior to the 8 November announcement. The report is prescient for the accuracy with which it described the logistical challenges that the country actually faced as a consequence of the note ban:

  Notes of denominations of `500 and `1,000 together accounted for approximately 85 per c
ent of the total value of banknotes in circulation at end March 2015, while together they accounted for 22 per cent of the volume at end March 2015.

  Despite the presence of high denominations, RBI had spent `37.62 billion in printing notes in 2014–15. If the notes of these two denominations are withdrawn, the cost of printing notes for RBI would also multiply.

  At the branch level, the cost of handling cash would zoom and there would be complete chaos as the funds kept in these denominations will be flushed into the banking channels. Currently there are around 5,000 currency chests across the country with the Banks that are used for storing notes. The capacity of these chests would need to be expanded 5x to enable storing of enough supply of currency to the public. Construction of these chests, which have specialized steel walls and doors, would take time and substantial investment.

  If the `500 and `1,000 denomination notes are removed, in order to maintain the same amount of liquidity, the number of other denomination notes will have to be increased… A high transaction ATM which runs out of cash once a day will fall short of currency several times a day. This is so because cash replenishment agencies will take a couple of hours to respond, and customers will be affected because of the downtime. The costs also shoot up by `15 billion.

  From the report, it is clear that the problems India faced after demonetization had been clearly analysed and spelt out by SBI in April 2016.

  The only details in the public domain, regarding planning at the RBI, are from R. Gandhi, the Deputy Governor in charge of the currency management division. In an interview in April 2017,8 on the day of his retirement, he described the note ban as a well thought-out and well-deliberated decision.

  In his interview, he made a number of interesting statements:

  ‘The consultations started in January. The introduction of `2,000 was a decision irrespective of demonetization.

  The decision to introduce `2,000 notes and the withdrawal of `500 and `1,000 notes were taken in parallel.

  We planned everything. Every reaction was fully foreseen. There was no nasty surprise for us. Everything had been well identified, and debated. Several instructions were given by us. But you need to analyse it differently. About 20 (notifications) were relaxing rules. These relaxations were also pre-planned. If at all, there were one or two without planning. The rest were planned.

  The board was apprised only one day prior to the move as we could not inform the board much in advance.’

  Gandhi’s statements seemed to indicate that the note ban had been planned since January 2016, at least within the currency management department of the RBI, making it even more shocking that its execution had been so flawed.9

  What Was the Role of the RBI Governors?

  In May 2016, Subramanian Swamy, MP from the ruling BJP, mounted a very public campaign against the RBI Governor, Raghuram G. Rajan.

  On 12 May,10 he attacked Rajan for the alleged failure of his policies, stating that, in his opinion, ‘the RBI Governor is not appropriate for the country… The sooner he is sent back to Chicago, the better it would be.’ Intensifying his campaign on 16 May,11 he wrote to the Prime Minister urging him to ‘terminate’ his services ‘effective immediately’ or when his term ends in September because he was ‘mentally not fully Indian’. In this letter, Swamy said he was ‘shocked at the wilful and apparently deliberate attempt by Dr Rajan to wreck the Indian economy.’

  On 26 May,12 he followed this up with a widely publicized ‘open’ letter13 to the Prime Minister in which he levelled six allegations against Rajan, including those of ‘sending confidential and sensitive financial information around the world’, and being ‘publicly disparaging of the BJP government’, which, in his considered opinion, required ‘terminating his services as RBI Governor immediately’.

  Such a public attack on the RBI Governor by an MP of a ruling party was unprecedented. While media speculated on its causes, there was no defence of Raghuram G. Rajan from any government official, nor any response to Swamy’s ‘open’ letter.14

  On 18 June 2016, Rajan, in a letter notable for its dignity and restraint that was addressed to all RBI employees, stated that he would return to Chicago, after completion of his three-year term as the Governor of RBI, to continue his academic career.

  I am an academic and I have always made it clear that my ultimate home is in the realm of ideas. The approaching end of my three-year term, and of my leave at the University of Chicago, was, therefore, a good time to reflect on how much we had accomplished… On due reflection, and after consultation with the government, I want to share with you that I will be returning to academia when my term as Governor ends on 4 September 2016. I will, of course, always be available to serve my country when needed.15

  On Saturday, 20 August 2016, the government appointed Urjit R. Patel as the next Governor of the RBI, stating that for the first time, a ‘systematic approach and objective mechanism’ had been put in place to select the person for the post.

  Urjit Patel, who had been serving as a Deputy Governor in the RBI since January 2013, had a distinguished academic record. He had completed his BA from the London School of Economics, MPhil from Oxford University, and his PhD in Economics from Yale University. He had worked at the IMF between 1990 and 1995, and was deputed from the IMF to the RBI in 1996–97. Between 1997 and 2006, he worked for Reliance Industries Limited as President of Business Development. From 2006–13, he was an independent director of the Gujarat State Petroleum Corporation (GSPC).

  The appointment was not without controversy. The Comptroller and Auditor General of India (CAG) had castigated GSPC for mismanaging its exploration- and development-related activities in its KG Basin and overseas assets, leading to higher costs and financial losses.16 Equally publicized at the time of Urjit Patel’s appointment was his association, as a non-executive director, with the controversial Multi Commodity Exchange of India Limited (MCX) headed by Jignesh Shah, the prime accused in the `5,600 crore National Spot Exchange Ltd (NSEL) scam.17

  Questions were therefore raised in the media about both his judgement and his ability to uphold the autonomy and integrity of the post of Governor of the RBI, given his previous positions as a director of companies that had been embroiled in scams during his tenure on their Boards.

  On 29 August 2016, Governor Raghuram G. Rajan signed his transmittal letter18 to Urjit Patel. The report19 attached to the letter is interesting, in that it mentions a significant indent for `1,000 and `500 notes (subsequently demonetized) that were printed in 2016. There is no mention of the new `2,000 notes, or of the planned demonetization exercise. On 4 September 2016, Urjit Patel took over as the twenty-fourth Governor of the RBI.

  Was Raghuram G. Rajan aware of the demonetization? Did he oppose it? Could this have been the reason for the orchestrated campaign to remove him from the position?

  When requested for information in early 2017, Rajan’s response was courteous but circumspect: ‘Sorry, not speaking on India till September 2017, and really cannot speak on discussions with the Govt. Many of your questions can be asked to RBI management. They can decide what they can answer.’

  On its part, the RBI declined to share any information. In response to numerous RTI requests by concerned citizens, it declined to furnish information citing section 8(1)(g) of the RTI Act. Shailesh Gandhi, the former Central Information Commissioner, whose previous rulings that the RBI must disclose information were upheld by the Supreme Court, said, ‘The RBI is treating the orders of the Commission, the Supreme Court, and the RTI Act made by Parliament, in complete contempt.’20

  Then in September 2017, Rajan broke his silence. Speaking at the launch of his book I Do What I Do, he disclosed that he had opposed demonetization as he felt the short-term economic costs associated with such a disruptive decision would outweigh any longer-term benefits from it.

  ‘I made these views known in no uncertain terms… At no point during my term was the RBI asked to make a decision on demonetization… I was asked by the gove
rnment in February 2016 for my view on demonetization, which I gave orally.’21

  Despite his reservations, the RBI was asked to prepare a note for submission to the government. Rajan said, ‘The RBI note outlined potential costs and benefits of demonetization, as well as alternatives that could achieve similar aims. If the government, on weighing the pros and cons, still decided to go ahead with demonetization, the note outlined the preparation that would be needed, and the time that preparation would take. The RBI also flagged what would happen if preparation was inadequate.’22

  Reinforcing these points in April 2018,23 Rajan said, ‘I have made it quite clear that we were consulted and we didn’t think it was a good idea,’ and ‘…Demonetization was not a well-planned, well thought-out, useful exercise and I told the government that, when the idea was first mooted.’

  Responding to a comment from the audience that demonetization could have positively impacted growth, Rajan said wryly, ‘You would have to find a new economic theory to explain how it helped the economy.’

  It is, therefore, evident from Rajan’s feedback that he was consulted on demonetization, but the RBI under his stewardship had indicated to the government in no uncertain terms that it was not advisable. The RBI had also clearly outlined the preparations that would be needed, and the consequences of inadequate preparations.

  Whether this was the reason for the orchestrated campaign to remove him will remain a matter of speculation. Given that Deputy Governor Gandhi’s statements seem to contradict those of the former Governor, it seems that if the RBI was involved in the planning, Rajan was not aware of this and that the ‘formal planning’ only commenced after Urjit Patel, his successor, was in position, on 4 September 2016.

  If Not the RBI, Who Were the Planners?

  To date there has been no official confirmation of the names of the members of the ‘small team’ constituted by the Prime Minister. There was considerable media speculation as to whether the Finance Minister himself had been consulted or was part of the team.