Defanged generals seldom win wars. The institutional mechanism proposed in the finance ministry’s revised draft of the Indian Financial Code (IFC) could well lead to such a situation when it comes to fighting the battle against inflation. The draft code, released for public discussion, moots vesting the powers to determine the interest rates of the RBI to meet inflation targets with a monetary policy committee (MPC). This committee will have seven members, of whom four will be appointed by the Centre. All decisions by the MPC relating to cutting or raising policy rates will be taken by a majority vote. While the original draft IFC, which was part of the Financial Sector Legislative Reforms Commission’s report in March 2013, empowered the RBI governor to override the MPC in “exceptional circumstances”, the revised version has no such provisions.
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The issue here is not about the desirability of an MPC or of subjecting the RBI to democratic accountability. The Bank of England, for instance, has an MPC. But out of its nine members, only four are appointed by the chancellor of the exchequer; the remaining five, including the governor, belong to the bank. The presence of four external members provides a forum for structured consultations between the treasury and central bank, while also enabling greater fiscal-monetary coordination. But the majority voting power with the central bank’s representatives ensures operational autonomy, which wouldn’t be the case where an MPC is overloaded with government appointees. As regards accountability to an elected government and Parliament, this automatically comes when the objective of monetary policy is established by the political authorities. That extends to inflation-targeting, if necessary. But once the goals are defined, the conduct of monetary policy in pursuit of these has to be left to an central bank free of political control.
The MPC arrangement proposed under the revised IFC draft undermines central bank independence while seeking to substitute democratic accountability with greater government say in monetary policy decisions. This comes, moreover, when India has officially committed to inflation-targeting. The monetary policy framework agreement between the RBI and the government, signed in February, explicitly fixes goals for annual increases in the consumer price index and specifically pins the responsibility of the central bank to achieve them. In the event of inflation targets not being met, the draft IFC even obliges the RBI to provide reasons and propose remedial actions. Any institution that has its hands tied cannot be held to such high standards of accountability. It is important to have a wider public debate on a change as important as the one proposed now, given its impact on institutional arrangements, and on monetary and fiscal management.