The Reserve Bank of India (RBI) Governor Raghuram Rajan delivered his bimonthly monetary policy review this week, keeping the key lending rates of India’s central bank unchanged. But the debate on the review this time was less over Governor Rajan’s monetary policy and more over whether monetary policy should even be his job at all.
The latest draft of the Indian Financial Code, recently made public and based on the suggestions of the Financial Sector Legislative Reforms Commission (FSLRC), proposed that the RBI Governor be stripped of his veto over monetary policy and the powers be given instead to a Monetary Policy Committee composed of members from both the government and the central bank. But what made the draft proposal more contentious than its earlier version was the proposed composition of the committee. Unlike the previous draft, which called for greater parity between members from the government and those from the RBI with the Governor retaining a veto, the latest Code provides for a 4-3 government-dominated committee without a veto in the hands of the Governor (though it is expected that the Finance Ministry will propose a six-member committee with three members from the government and three from the RBI).
The amendments have naturally raised a storm over the independence of the RBI, but not everything is as simple as it seems. In a media interaction published in the Business Standard, Rajan explained that the RBI currently has “de facto independence” rather than de jure independence. And the Governor is right. Under the existing RBI Act, the Governor and most of his executive board are appointed either directly or indirectly by the government. The Act stipulates that the RBI will follow any advice tendered to it by the government – something that Rajan says has never been insisted upon by the government in the entire history of the RBI. In addition, the Governor has a sweeping veto on matters regarding monetary policy, independent of scrutiny even by his own colleagues in the central bank.
If the current law is anything to go by, a Monetary Policy Committee would actually be a better arrangement for the RBI, says Rajan himself. The committee, if properly formed, would institutionalise autonomy in monetary policy formulation. It would bring continuity in monetary policy, despite changes in the governorship. Plus, it would bring other advantages, like deconcentrating the power possessed by a single individual (the Governor, in this case) and allowing for pluralism of viewpoints in the formulation of monetary policy.
But a government-dominated Monetary Policy Committee is a totally different animal. The RBI’s voice would then be reduced, possibly, to a mere formality, and monetary would be subjected to the whims of the elected government. Elected governments, in any system, are given to populism rather than sound long-term macroeconomic policy. Unlike many other variables in government policy, monetary policy is a long-term game. Doing what’s right may not necessarily bring short-term electoral gains for the ruling political dispensation. And populism may well end up endangering the economy in the long run. As such, monetary policy is best left in the hands of expert economists who have little to gain from making populist calls, or giving in to government demands.
What the government needs is a Monetary Policy Committee that is halfway between the RBI Governor (a one-man show) and the elected government (susceptible to populism). A committee of technical experts, chosen perhaps by a selection committee composed of RBI and government representatives, is one possible solution. Another would be an independent committee formed by the RBI Board of Directors themselves. Such a committee, in turn, would need to be given sufficient statutory autonomy to function without fear or favour.
The time has probably come for India to institutionalise autonomy and accountability in the formulation of its monetary policy. Monetary policy can’t be left to the whims of one man or even the populist adventures of an elected government. Whatever Monetary Policy Committee is agreed upon today may well stand for years to come. That is why the Finance Ministry must be careful in deciding its composition.
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