The controversy over setting the framework for Indian monetary policy has revived the age-old row between the Indian government and the Reserve Bank of India (RBI).
The recent revival of the divide between the Indian government and the RBI has come to the fore with the unveiling of the draft Indian Financial Code (IFC) ‘version 1.1’.
The description of the revised IFC as ‘version 1.1’ was added in retrospect by the Finance Ministry after it was forced to revert to a defensive position on the allegations that it sought to curb the authority of the RBI through the medium of the proposed Monetary Policy Committee (MPC).
That the RBI autonomy was sought to be compromised becomes clear by the fact that nobody seems to want to own up to the responsibility for coming up with the controversial provisions. The Finance Ministry has passed the buck to the now-defunct Financial Sector Legislative Reforms Commission (FSLRC), established in 2011 and dissolved in 2013 after it submitted a report on financial sector regulation.
The current controversy centres on four issues. One, the latest draft IFC gives sweeping powers to the government in appointing the members of the proposed Monetary Policy Committee (MPC). The upshot is that the draft code proposes that four out of seven members will be government nominees, thus giving the government unprecedented powers over the RBI’s monetary policy.
In principle, there is nothing wrong with this proposal, as under the RBI Act of 1934, even though the governor has the power to set the interest rates, they will ultimately be subject to the authority of the government. Given the electoral commitments of the successive governments, however, the government is not often on the same page with the RBI on the issue of interest rate cuts.
Second, the draft IFC seeks to curb the veto power of the RBI Governor. Instead, the Governor will have a second and casting vote in the event of a tie among the members of the MPC.
Third, highlighting the exercise of discretionary or surveillance powers of the government, the proposed committee would also have one government ‘representative’ who will simply observe the proceedings but not vote, unlike other members who also have to justify why they have voted in a particular manner.
Fourth, the RBI has been circumscribed by the framework of ‘inflation targeting’, in contrast to the RBI’s ‘multiple indicators approach,’ which include a number of other regulatory functions besides inflation-targeting.
The other side
The widespread attacks on the draft IFC have also drowned two pertinent issues – the relevance of setting up the MPC, and whether the RBI had the kind of legal independence that could be compromised.
The RBI never had any statutory independence to begin with. The archaic 1934 RBI Act gives the government the final say over interest rates and appointments in the central bank. Therefore, the MPC will not compromise the independence of the governor, even if it has four external members out of seven.
Moreover, the proposal to establish the MPC is, in principle, a positive development that coheres well with the changed international standards in monetary policy since the 1990s. As a committee framework is more democratic and decentralized, it is thereby considered better as an inflation-targeting framework than vesting power solely in the hands of the central bank governor.
Currently, the RBI governor is not bound by the recommendations of the technical advisory committee. There is no system of accountability to which the governor can be subjected, unlike comparable countries (like New Zealand) which have such a system despite concentrating powers in the hands of the governor. This is why even the current RBI governor, Raghuram Rajan, favours the government decision in the IFC to constitute the MPC.
Another positive proposal is to set inflation targets (the proposed target is 4%, with a tolerance level of near 2%) and enact a system of collective accountability to meet them. This will serve to promote greater transparency in the system, and thus clarity.
Political roots
The debate over monetary policy adjustment is closely linked to the robustness of the fiscal policy in India. Currently, the RBI is facing pressures on two counts – cutting interest rates to spur investment, and controlling inflation. Both would remain incomplete without structural reform in the fiscal policy of the government.
India’s financial sector policies are closely linked to its larger political economy of developmentalism, favouring the dominance of Public Sector Banks and heavy subsidies for the poor in areas like food – which, unfortunately, rarely reach their target audience due to corruption and an inefficient Public Distribution System.
As of March 2014, Public Sector Banks had a market share of 73.2% and 73.9% in credits and deposits, respectively, with the State Bank of India alone accounting for about a quarter of the market share in both credits and deposits. Thus, even the policy of financial inclusion in India mainly leverages the power of government banks. To move away from this policy of government dominance would mean losing the votes of a sizeable section of the population.
Thus, whether or not the MPC will be a good idea will remain a purely theoretical debate, unless the specificity of the Indian context – marked by the risky tendency towards the erosion of institutions for political purposes – is recognized.
