If one were to accept the corridor gossip these days, it seems that an agreement has been reached between the RBI and the government on the composition and governance of the monetary policy committee (MPC), which will determine interest rates in India. Much of the media had been critical of the changes the government had suggested to the Financial Sector Legislative Reforms Commission (FSLRC) recommendations to take away the governor’s veto, and averse to its intent to appoint a majority of the independent members. This disparagement abated once the governor himself signalled his agreement with not having a veto. In fact, the Urjit Patel report itself had not given the governor a veto, only a casting vote in the event of a tie, but had recommended that the RBI be allowed to appoint the independent committee members. In the face of likely agreement, is there a point for an article on the subject? I think so.
Let me contextualise this with a brief story. Ten years ago at a dinner I had asked Y.V. Reddy what the best regulatory structure for banking supervision was and whether he thought the Financial Services Authority (FSA) structure of the United Kingdom might be it? I am unlikely to ever forget Reddy’s reply. He said: “For a man of your intelligence that is a particularly stupid question. In my view the critical things about good regulatory structures are two — the competence of the people who man these bodies and whether the people who man these bodies are actively disliked by the people they oversee.” He went on to add, “At least on the second count, I am comfortable that Indian bankers greatly dislike me!” This is an important lesson on which there is no debate currently. All the focus is on the veto and the right to appoint, none on the quality of those appointed. Also, there is little discussion on the alignment between accountability and authority.
More than two decades ago, I was doing my PhD at Princeton. As part of the qualifying requirements for the PhD, students had to write a paper of journal quality. The topic of my paper has relevance. I had examined the relationship between central bank autonomy and inflation by doing a case study on the RBI. The PhD programme coordinator at that time was Ben Bernanke, who was one of three who had to approve. In my paper, I examined the contention, proposed by Alex Cukierman, Bilin Neyapti and Steven Webb, that, first, a strong central bank is likely to emerge when the government is financially healthy, and the banking sector is financially independent of government and, consequently, industrialists do not seek recourse to government credit. Second, that a strong central bank is likely to be a very important institutional mechanism to control inflation. The Indian story did not bear this out. Despite the good health of the government of India, the central bank that emerged was not institutionally autonomous. Further, despite the institutional weakness of the RBI, inflation in India between 1950-84 averaged just 7 per cent per annum (versus the 19 per cent that the model of Cukierman et al would have predicted), quite modest by emerging economy standards. Between 1985-86 and 1997-98, it ranged around 8 per cent and between 1998-99 and 2008-09, it hovered at around 5.5 per cent. Between 2010 and 2014, it had spiked to around 10 per cent on a consumer price index basis.
The point I am trying to make is that we should not get carried away with structure. The people who man structures are important, and the political economy of a nation is critical. The Indian political class understands well that nothing is a bigger vote-killer than inflation. So, relatively speaking, India has had low inflation. Further, the autonomy of the RBI, though considered to be constrained by Cukierman et al’s model, has actually been considerable. It has been asserted through the personalities of RBI governors and has been reflected in their stature. Since at least 1982 till Reddy’s time in office, the relationship with the government was mostly cordial and one of mutual respect and accommodation. Since that time, it has become a bit more contentious and antagonistic. Because of this continuing antagonism, current debates are getting caught up in a win-lose narrative.
It is important to have this basic context before we opine on the debate. The MPC could be an improvement on the current situation if it gets good members and their published opinions provide transparency on the RBI’s thinking on interest rates. There can be an argument for a majority vote if we believe five heads are better than one. However, other than concerns on the quality of people appointed, there are some incentive issues that arise. Five heads may be better than one, but not if only one is accountable and the others can opine without responsibility. So, the majority view has its puts and takes. Further, the debate on composition also needs to be informed by realistic notions of independence. If indeed the MPC will have three RBI members, we must assume with certainty that the executive director will vote with the governor. It is possible but not plausible that the deputy governor will vote against. Perhaps if he is retiring with no prospect of reappointment, or if the governor is unpopular and nearing retirement.
Given all this, my suggestion for the MPC would be to build on the elegant formulation of P. Chidambaram. Have six members that include the governor, the deputy governor in charge of monetary policy, one independent member appointed by the governor and three independent members appointed by the government. The governor should get a casting vote in the event of a tie. However, let us remember, structure in itself is no panacea. It will be critical to choose the people who get appointed with care. Unfortunately there has not been much debate on that.
The writer is chairman, Asia Pacific, the Boston Consulting Group. Views are personal.