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Monetary policy committee: Will the Reserve Bank Governor have the last say?

The revised IFC proposes to do away with the veto power enjoyed by RBI Governor on policy rates, instead suggesting a decision by a majority vote.

Written by Surabhi |
Updated: July 28, 2015 6:28:49 am
Raghuram Rajan, RBI RBI Governor Raghuram Rajan

The release of a revised draft of the Indian Financial Code last week may have finally set the stage for an overhaul of the country’s financial sector regulations and architecture but it has also opened up a debate on who should have the ultimate responsibility for deciding the monetary policy stance.

Much of the revised IFC continues with the proposals of the original code but a massive change is the proposed re-aligning of the powers of the Reserve Bank of India (RBI) vis-à-vis the finance ministry through the composition and functioning of the monetary policy committee (MPC) that would be responsible for setting rates.

“The objective of monetary policy is to achieve price stability while striking a balance with the objective of the Central government to achieve growth,” said the revised IFC, proposing to do away with the veto power enjoyed by the central bank Governor for determining policy rates, instead suggesting a decision by a majority vote.


This is a major shift from the current practice where the RBI Governor can take his decision on the interest rate even though he is consults the Technical Advisory Committee on policy rates that includes Deputy Governors of the central bank as well as experts and economists.

Interest rates form the core of the tussle between the Centre and the RBI, with the finance ministry often pitching for lower rates to boost growth while the central bank opting for a more careful policy keeping in mind a number of factors such as inflation.

But experts are split on their views on how the proposals would impact the RBI’s mandate in setting interest rates with some arguing that it would not only take away autonomy but also downgrade powers of the central bank. Finance minister Arun Jaitley on Monday, however, tried to soothe these concerns and said, “The Financial Sector Legislative Reforms Commission (FSLRC) has made its recommendations, which have been made public for comments. After the comments are received, it is only then that the government will take a view.”

The finance ministry has sought public comments till August 8.

draftsMinister of state for finance Jayant Sinha said that the government will take a decision after “considering its (RBI’s) views”. RBI Governor Raghuram Rajan had met Prime Minister Narendra Modi on Friday and one of the items discussed at the meeting included the revised FSLRC code.

But contending that the new monetary policy framework agreement puts the onus on the RBI to control inflation, former RBI Governor C Rangarajan said, “Under these circumstances, if at all an MPC is required, the majority of its members must come from RBI. This will avoid the question of veto powers for the RBI Governor while making it more accountable for maintaining the inflation rate within a specified zone.”

Another former RBI Governor agreed: “There is no problem with the setting up of a MPC. But the ultimate responsibility for setting the interest rates must reside with the RBI Governor because who else can take hard decisions in difficult times.”

The IFC holds its origins in the FSLRC — headed by Justice BN Srikrishna — that was set up in 2011 to review the country’s financial sector architecture and submitted its report in March 2013. The two-part report included a volume on analysis and recommendations and another with the draft IFC. In the original draft of the IFC, the RBI chairperson was envisioned as the first amongst equals and had the power to “supersede the decision” of the committee in “exceptional and unusual circumstances” though decisions normally would be taken by the majority vote.

In the revised draft, the chairperson does not enjoy any such power but will have a second and casting vote in case of tie.

The MPC would consist of seven members including the RBI chairperson. The other members would include one executive member of the Reserve Bank Board nominated by the Reserve Bank Board; one employee of the Reserve Bank nominated by the RBI chairperson; and four persons appointed by the Central government. Additionally, the Centre would be allowed to nominate one representative to attend all the meetings of the MPC and take part in deliberations but he or she will not have a vote.

The RBI will be expected to publish a report every two months on the sources of inflation and the forecast for inflation for next six to 18 months. Further, in case, the inflation target is not met, the RBI would submit a report to the Centre on the reasons.

The original draft of the IFC, too, had suggested seven members in the MPC but with more play to the RBI chairperson in selection of the members. Apart from the RBI chairperson, the MPC was expected to consist of one executive director of the RBI. The Centre was expected to appoint two members in consultation with the Reserve Bank chairperson apart from three other members it could appoint independently.

Significantly, the RBI and the finance ministry had early this year signed a monetary policy framework agreement — a key recommendation of the Urjit Patel committee on monetary policy reform — under which the central bank would target retail inflation for policy rates. This is in line with the Urjit Patel committee, submitted in March 2014 that called for the nominal anchor or the target for inflation should be set at 4 per cent with a band of +/- 2 per cent around it.

But the committee’s recommendations on composition and working of the MPC gave more say to the RBI Governor. It had suggested a five member MPC with “each member having one vote with the outcome determined by majority voting, which has to be exercised without abstaining”. However, the chairman, or in his absence the vice chairman, was sought to be given a casting vote in case of an exigency or a tie.

But the finance ministry and the RBI have remained markedly silent on the setting up of a MPC, with finance ministry officials saying that it is a work in progress. “I hope, sooner rather than later, to introduce the IFC in Parliament for consideration,” Jaitley had announced in the Union Budget 2015-16.

The finance ministry is expected to table IFC Bill in the Winter session of Parliament. It will finalise the code and send it to the Ministry of Law for legal vetting and then take it to the Union Cabinet for approval.

Once tabled, the proposed code will also have to pass muster with the Standing Committee on Finance that can suggest further changes. “There seems to be some confusion with the fresh draft of the IFC and it needs to be reviewed — either now or later in Parliament. The monetary policy stance can not be decided on the basis of a committee,” said a former official with the RBI.

However, Ajay Shah, professor, National Institute of Public Finance and Policy and head of the technical team for FSLRC wrote in a blog post on July 23: “IFC v1.1 (revised draft) is a polished product. With the benefit of 853 days of elapsed time, many blemishes have been found. The code is much more orthogonalised: general concepts are consistently applied”. “We welcome the transparent monetary policy framework of flexible inflation targeting set out in the draft Indian Financial Code … The government will provide the RBI with a 3-year CPI inflation mandate that will be targeted by a 7-member statutory MPC, chaired by the Governor. While it will likely take time to be enacted, we see the Indian Financial Code as a step in the right direction,” said a research report by Bank of America Merrill Lynch.

Internationally, MPCs function in different ways but decisions are taken largely through a consensus. For instance, the nine-member MPC of the Bank of England meets every month to set the interest rates. Its decisions are made on the basis of one-person, one vote and is not based on a consensus of opinion. On the other hand, the US Federal Reserve’s Federal Open Market Committee (FOMC) consists of twelve members and holds eight regularly scheduled meetings per year. Each of the FOMC members discusses their policy preferences and then vote. But it is expected to reach a consensus on the appropriate course for policy.

Similarly, for the European Central Bank, the governor council is the main decision making body. It consists of the six members of the Executive Board, plus the governors of the national central banks of the 19 Euro area countries.

While the ECB’s Executive Board members hold permanent voting rights, these are rotated between the member nations. Each member gets a vote but the objective is to reach a consensus for a decision.

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