As India moves towards the implementation of an inflation-targeting mechanism, the debate about the structure of this policy has intensified. Till date, monetary policy has been the exclusive domain of the RBI, and within the RBI, under the exclusive and sole discretion of the governor. To be sure, the RBI has a large and competent staff that gives inputs to the governor. In addition, the governor has a seven-member technical advisory committee (TAC), composed of non-RBI experts who deliberate on and recommend monetary policy, including repo rates, to the RBI.
However, the RBI is not bound by the TAC’s recommendations. In this regard, the RBI governor has complete and absolute authority on monetary policy, as do his counterparts in Latin America (for example, Brazil, Chile, Mexico) and New Zealand (a partial list of countries where the central bank governor has absolute authority).
In March 2011, the previous UPA government appointed a nine-member Financial Sector Legislative Reforms Commission (FSLRC), under the chairmanship of former Supreme Court judge, Justice B.N. Srikrishna. The commission was to decide on various regulatory aspects of Indian financial institutions, including the RBI. Justice Srikrishna had just completed (June 2010) a tenure for the UPA government on the bifurcation of Andhra Pradesh, which eventually did happen in 2014.
UPA finance ministers (P. Chidambaram and Pranab Mukherjee) consistently had problems with RBI governors.
Possibly because of these strained relationships, the FSLRC seemed to endorse the view that the RBI’s wings needed to be clipped, and then some. In the first FSLRC report (V1.0, March 2013), the proposal for monetary policy implementation was as follows: “…the creation of an MPC [monetary policy committee] that would determine the policy interest rate. In addition to the chairperson and one executive member of the board, the MPC would have five external members. Of these five, two would be appointed by the Central government, in consultation with the chairperson, while the remaining three would be appointed solely by the Central government.” However, V1.0 did allow the RBI governor veto power over MPC decisions under “extreme circumstances”.
The FSLRC’s V1.0 was a mixture of vote and veto — two members from the RBI (governor and deputy governor for economics and monetary policy), two external members selected by the governor and three selected by the Central government. All five would, however, formally be appointed by the Central government (ministry of finance, or MoF). Implicitly, four of the five external members of the MPC would have to agree to a course of action different from the governor’s to override him.
Subsequently, the RBI’s Urjit Patel Committee report, in January 2014, recommended an MPC with a different balance. The report advocated inflation-targeting along with an MPC, and the latter was to be constituted as follows: “The governor of the RBI will be the chairman of the MPC, the deputy governor in charge of monetary policy will be the vice chairman, and the executive director in charge of monetary policy will be a member. Two other members will be external, to be decided by the chairman and vice chairman on the basis of demonstrated expertise and experience in monetary economics, macroeconomics, central-banking, financial markets, public finance and related areas.” This report was noteworthy for the fact that it would be near-identical in its power structure to the present, no-MPC structure, that is, the RBI is in control. Even if both external members of the MPC disagreed with the governor, he would always have at least a 3-2 majority.
On July 23, the FSLRC responded with its Version 2.0 of the MPC, which would comprise of three members of the RBI (instead of two earlier) and four external members nominated by the MoF — and no extreme circumstances and no veto power! This recommendation goes against almost any definition of an independent central bank — and, in our view, will not be acceptable to the MoF or the government.
The table lists the practice of monetary policy in 15 selected countries. As is well-known, the US system of setting rates is based on “consensus”, with seven of the 12 FOMC (Federal Open Market Committee) members being selected by the president and ratified by the Senate. The other five rotational members are regional bank heads and are, therefore (implicitly), appointed by the central bank.
The FSLRC’s V2.0 is comparable to a few of the selected countries — for example, Korea, Norway, the Philippines. While some sections of the media have suggested that the Indian structure is similar to Thailand’s, that is not the case. While Thailand does have a seven-member committee, all seven members are appointed by the central bank.
Our first proposed structure (and the one we really prefer) is that the MPC be a formal five (seven)-member body with the governor as chairman and four (six) outside professional experts as members. The tenure of each member should be five (or seven) years. The experts cannot be employees of either the RBI or the government of India. All four (six) members must have knowledge and expertise in macroeconomics and monetary and/ or fiscal policy. The government will have the right to suggest a list of names for the consideration of the RBI, but the governor will have the right to choose and appoint those he wants, subject to the above criteria. The decisions of the MPC will, however, be binding on the governor. This means that if, and only if, three (four) of the four (six) independent members of the MPC agree on a policy course different from that proposed by the governor, would he be obliged to accept their decision.
Israel seems to have the best mix among the existing systems. The governor chairs the MPC, consisting of six members, with three outside members selected by the government. In case of a tie, the chair has the deciding vote (not clear on Israel’s central bank website). This is our second proposed structure for the MPC, based on the best in emerging-market practice. Again, we would recommend a five (or seven)-year term.
Regardless of which of our proposed structures is adopted, we want to emphasise that it is important that the RBI have both the responsibility and accountability for monetary policy. It should also be, and seen to be, independent of the government of India. Finally, accountability of the RBI would mean twice-a-year presentations (and grilling!) by parliamentarians, not unlike the practice in the US. The latter, of course, cannot happen if Parliament is not allowed to function.
Bhalla is chairman, Oxus Investments and senior India analyst for the Observatory Group, a New-York based macroeconomic policy advisory firm. Virmani is former executive director, IMF, and former chief economic advisor, ministry of finance