So much has happened that is cause for grief, concern or plain disgust. The universally admired Dr A P J Abdul Kalam passed away. There was a terror attack in Gurdaspur. Amidst a debate on the legality and morality of the death penalty, Yakub Memon was hanged. Cases of molestation or rape continue to be reported every day. Government is unwilling to yield to break the logjam in Parliament.
This week, I would like to draw attention to an issue that is of paramount importance to the economy.
The issue is, ‘who will decide the monetary policy?’. For the average person, the question can be rephrased to read ‘who should decide the policy that will determine the rates of interest at which commercial banks will lend money?’. The average person will be right if he assumes it is the government’s job, but within the concept of ‘government’ there are many authorities that are empowered by law to function autonomously and not as an arm of the executive government.
Balancing Growth & Inflation
The Reserve Bank of India (RBI) is one such authority. RBI is no ordinary bank. It is the central bank, the issuer of currency and bonds, the regulator of commercial banks and non-banking financial institutions, and has other functions as well. In modern economies, it is the central bank that decides the monetary policy. The unstated premise is that the central bank will consult the government. The optimistic belief is that the government will (or should) always agree with the central bank. Alas, that is not true!
The government is concerned with growth, investment and jobs — and also inflation. Only a foolish government will believe that it can ignore inflation as long as there is growth and jobs for the people. A wise government will look for a ‘balance’: in a developing country the balance is usually expressed in the phrase ‘high growth with moderate inflation’.
The central bank’s main concern is price stability. In developed countries and in some developing countries, the central bank has just one target — inflation. Many central bankers believe that the central bank must target inflation and only inflation. All recent RBI governors held that view. It appears that Dr Raghuram Rajan also holds the same view, although I can recall conversations with him that led me to think that he did not rule out seeking a balance between promoting growth and targeting inflation.
Not at loggerheads
There is a popular view among commentators that finance ministers and central bank governors are always at loggerheads. That view may make interesting copy, but it is far from the truth. On 8 out of 10 monetary policy statements or actions, the government and the RBI will be — and in the past, have been — on the same page. There will, of course, be the occasional disagreement, but that disagreement stems from different assessments of the economic situation at any given time. For example, the government has assessed the current economic situation as non-inflationary and therefore desires a cut in the policy interest rate to stimulate growth. On the contrary, the RBI has assessed the situation as still high on inflationary expectations and therefore wishes to maintain the policy interest rate. No one can be sure who is right. There appears to be an honest disagreement between the government and the RBI.
We need a mechanism that will reconcile the perceptions of the government and the central bank and take an objective view. The Financial Services Legislative Reforms Commission (FSLRC) has proposed a mechanism: a Monetary Policy Committee (MPC) on the lines obtaining in many countries.
Rival proposals on MPC
No one seems to be opposed in principle to the MPC or the qualifications and independence required of its members. Differences have emerged regarding the composition and authority of the MPC. FSLRC has advocated a 7-member MPC with three members of the RBI and four external members nominated by the government. The RBI (Urjit Patel Committee report) has recommended a 5-member MPC with three members of the RBI and two external members chosen by the RBI. Decisions on monetary policy will be taken by a vote in the MPC. In both proposals, a vote is envisaged, but not a veto to the governor.
I wonder who brought up the question of a veto to the governor. A veto is the antithesis of a vote. A vote and a veto co-exist uneasily and with unhappy consequences only in the UN Security Council!
My view, though unconventional, is there may be a 6-member committee — three from the RBI and three external members nominated by the government. In the case of a tie, let the governor have a casting vote. The minutes must be made public. Assuming the three internal members vote alike, the governor needs to persuade at least one external member to agree with him, and on most occasions he will. In situations where all three external members disagree with the three internal members, it will be a brave governor who will vote, every time, in his own favour to break the tie.
I reject the argument that the government cannot be trusted to nominate qualified or independent members. Governor Rajan was appointed by the UPA government and we are proud of the choice. So, let’s have a six-member MPC and give the governor a casting vote, but put the onus squarely upon him.