Separate monetary policy panel, a welcome move

The move of the government to a committee-based monetary policy, particularly fixing policy rates, stems from two sources viz., Financial Sector Reforms Commission (FSLRC), 2013, and Urjit Patel Committee on Monetary Policy Reforms (2014) recommendations.

The Indian Finance code (IFC) by the FSLRC was revised and posted on the Ministry of Finance (MoF) website as draft IFC on July, 25, 2015 for public review and comments till August, 8, 2015. The draft IFC mainly deals with the composition of the Monetary Policy Committee (MPC) along with focus on a monetary policy framework, capital controls etc.

However, the point of debate among academicians and policy makers has been on composition of the MPC and whether it affects the autonomy of Reserve Bank of India (RBI), which has been doing a commendable job in maintaining price stability and securing Indian markets from external shocks. The MoF’s draft IFC proposes a MPC comprising seven members, with four  being nominated by the government without veto power of the RBI governor.

Though the draft IFC appears to dilute the autonomy of the RBI by taking away the veto power of its governor, the recent announcements by MoF officials and the RBI puts things in perspective. Overall, the development augurs well for an effective MPC for monetary policy in India.

Initially, IFC suggested a seven member committee chaired by the RBI governor where three members would be appointed by the governor’s approval and other three by the central government. With the power of casting vote, the RBI governor’s vote would be like a veto power. However, the draft IFC of the MoF has put the central government in the driver’s seat with the power of appointing four members in a seven member committee.

Though the overriding powers of the Centre in an extraordinary situation as proposed by the FSLRC has been done away with, it has been neutralised more than adequately as the government now would have the power to influence the MPC’s decision every time. Therefore, if the draft IFC gets the cabinet approval in its present form, it would certainly dilute the independence of the RBI as the decisions would be taken by the majority in MPC.

This is a major shift in the monetary policy in India as the RBI governor loses veto power, which was used in setting policy rates sometimes even overriding the recommendations of technical advisory committees of RBI and other inputs. However, the latest update is, as reported, that both the RBI and the finance ministry have arrived at a middle point where the central bank and the government will have three members each and the RBI governor would have the voting right in case of a tie.

The committee-based monetary policy is the norm in majority of countries following inflation targeting, which has also been mentioned in the draft IFC by MoF. In fact, the Urjit Patel committee report suggests a move towards a committee-based approach for greater transparency, accountability and space for diversity of opinions.

Advantages of moving from the present monetary policy decision-making, where the RBI governor almost takes a solo decision, to MPC will give more space to diverse  views and experienced and independent opinions. Moreover, inflation is not always a monetary phenomenon, more so non-core food-fuel inflation which is mostly caused by the supply side shocks.

It has been argued that single-minded inflation targeting monetary policy has negatively affected in augmenting supply side leading to persistent inflation. In recent years, India has experienced divergence between monetary and fiscal policy leading to inability of monetary policy in managing inflation.

A proper forum

Thus, MPC provides a proper forum for policy coordination between the government and the RBI for effective monetary policy mechanism. It is also true that an emerging market like India with growing aspirations cannot have one single monetary policy objective, i.e. inflation targeting.

The selection of non-RBI members, government appointees, will be experts in the subjects chosen by the selection committee. Therefore, it is expected that members will use their expertise in stating their views and votes for the best in achieving monetary policy targets.

In fact, the draft IFC makes members accountable through provisions such as allowing them to make a single statement justifying their opinion and vote, making MPC minutes public within a fortnight and publication of full transcript of the MPC meeting.

It is expected that MPC members, now equal numbers both approved by the RBI and appointed by the government, would be voting on proper economic grounds and reasoning rather than any loyalty and ideology. Therefore, MPC is the right way to go about achieving monetary policy framework. The present RBI governor, too, has supported this for better judgement on monetary policy.

However, the tussle over composition is the reflection of conflict of motives. The RBI mandate is clearly defined as an inflation targeting approach even while considering growth objectives, as per the MoU signed by the government and the RBI in February 2015. However, the executive wants the growth objective with lower interest rate while the RBI wants inflation targeting with higher rates, which it perceives right.

The draft IFC gives equal importance to both inflation and growth unlike the RBI’s sole objective of achieving inflation targeting. Given the moderation in inflation in recent quarters, there has been a demand for rate cuts by the industry but RBI has so far resisted large cuts only to maintain price stability.

India is an emerging and a dynamic economy. Therefore, MPC, which gives space for policy coordination to achieve multiple monetary policy targets, is welcome. However, the RBI as an institution commands credibility and has done a commendable job so far. India has been less affected by several crisis in the past due to the RBI’s independence in managing monetary policy.

Given the possibility of interest rate rise in the US sooner or later leading to capital outflows from India and subsequent fall-out on exchange rate and macroeconomic impact, MPC should not, in any way, try to dilute the independence of the RBI.

(The writer is Associate Professor, Institute of Economic Growth, Delhi University)

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