Since he took charge as Governor, Reserve Bank of India, in September 2013, Raghuram Rajan chose to go against the majority view of a central bank panel on three out of seven occasions on the need for a policy rate change. At present, a technical advisory committee (TAC) comprising seven members and chaired by RBI Governor meets ahead of the review on policy rates, following which the Governor enjoys almost absolute powers on setting rates.
Tuesday’s monetary policy review comes in the backdrop of a very public debate raging on the recommendation of the draft financial code released on July 23 by the finance ministry, which is now at pains to distance itself from the controversial proposal that has rekindled the debate on who should have the ultimate responsibility for deciding the monetary policy stance — the central bank or the government. On July 25, two days after the Indian Financial Code (IFC) proposed by the Financial Sector Legislative Reforms Commission (FSLRC) was made public, Minister of State for Finance Jayant Sinha had to step in to clarify that the contents of the report did not “represent” government thinking. Then on Monday, finance secretary Rajiv Mehrishi, at a hurriedly called press briefing, again dismissed reports that the government was trying to curtail the central bank’s powers on monetary policy.
Currently, the TAC includes deputy governors of the central bank as well as experts and economists appointed by the RBI. Between September 2013 and January this year, the RBI had raised the repo rate (the rate at which banks borrow from the central bank) thrice, by 25 basis points each (a basis point is a hundredth of percentage point) while it has cut rates thrice since then. Of these, two rate hikes and one cut were by way of out-of-cycle interventions by the central bank. In four out of the seven TAC meetings since September 2013 where the RBI Governor went with the panel’s view, two instances involved a rare unanimous decision by all the seven members on the broader call — once in favour of a cut and the other on holding rates. The governor’s decision to go against the TAC’s majority view was attributed largely to the central bank’s overall hawkish stance against the inflationary trend in the economy.
At a policy meeting on April 7 this year, for instance, four out of the seven external members of the TAC had suggested that the RBI cut its key rate, but the suggestion was vetoed by Rajan, according to edited minutes of the meeting released by the central bank. Rajan had retained RBI’s benchmark repurchase rate, the rate at which the central bank lends to commercial banks, at 7.5 per cent then.
Before that, in September 2014, four of the seven outside members of the committee had wanted a cut in interest rate — with three calling for a 25 basis points cut as there were signs of inflation easing and one members pointing to a case of reducing it by 50 basis points. The Governor, though, decided on keeping the repo rate at 8 per cent in the September 30 policy review.
Earlier, after a meeting on January 20 last year, Rajan went against majority view in the TAC while announcing a surprise 0.25 per cent hike in key rates in the January 28 policy review. Only two members called for a hike in interest rates citing the pressures on inflation, with one asking for the key repo rate to be cut to accommodate concerns on growth while a majority — four members — asked for a status quo.
While most of the provisions of the revised IFC are in line with the proposals of the original Code, the big change is the proposed re-jigging of the powers of the RBI vis-a-vis the finance ministry through the composition and functioning of the monetary policy committee (MPC) that would be entrusted with setting rates in the future. The wording of the draft code highlights the continued tension between the desire for growth and the need to curb India’s traditionally high inflation.
“The objective of monetary policy is to achieve price stability while striking a balance with the objective of the Central government to achieve growth,” it said. Under the proposed code, it would remain the responsibility of the RBI to ensure that inflation targets are met, even though central government members would have a majority of the votes on the MPC.
The MPC design is broadly taken from structure followed by the Bank of England for rate-setting. The BoE minutes do not disclose names but barring a few dissents, the chair’s view usually goes through. According to reports, there was just one major publicised fight between then BoE chief Mervyn
King and its MPC member David Blanchflower, where the latter pitched hard for a cut in rates as the 2008 financial crisis was just setting while the former decided to overlook his advice.
In India too, interest rates are at the heart of the slugfest between the RBI and the finance ministry, with the latter making a strong pitch for lower rates to boost growth even as the central bank has maintained a less optimistic view when faced with the threat of inflationary signals in the broader economy. The finance ministry has sought public comments to the IFC proposals till August 8.