On June 27, 2016, the government amended the RBI Act to provide for the setting up of Monetary Policy Committee [MPC] with the mandate to fix interest rates and inflation target. The necessary notification in this regard has been issued and process of its constitution initiated which should be consummated within 2 months or so.
The bi-monthly monetary policy review slated for early August, 2016 will be the last time when the interest rate would be decided under the existing dispensation. This will also more or less coincide with the end of the tenure [September 4, 2016] of present governor Raghuram Rajan who has decided not to seek another term.
Under the existing dispensation, a decision on the policy rate [or repo rate: interest rate at which the apex bank lends money to commercial banks] and other policy parameters such as cash reserve ratio [CRR] [funds as a percentage of deposits that banks have to keep with RBI] is the sole prerogative of the RBI governor.
Though, there is a technical advisory committee [TAC] advising RBI on monetary policy decisions, the governor is not bound by its recommendations and is free to take his own decision [in consultation with his internal team]. Indeed, on several occasions in the past, the guv has totally ignored the committee’s recommendations.
MPC is all set to break the monopoly of the governor. The committee will have 6 members consisting of 3 members from RBI viz., the governor [who will also be its chairperson], deputy governor and an official. 3 independent members will be nominated by GOI vide a search committee [includes cabinet secretary, secretary, economic affairs, RBI governor and three experts in the field of economics, banking and finance]. The decisions will be taken by majority vote; in the event of a tie, governor will have a casting vote.
The critics argue that this is an infringement on the autonomy of the RBI and will seriously undermine its role as an independent regulator, all the more, as GOI being an important stake holder [it is the largest borrower from the banking system]. Some even opine that henceforth, finance ministry will have complete command over a function that should be strictly under RBI’s jurisdiction. This thinking is flawed.
The task is being entrusted to a committee that has equal number of representatives from RBI and GOI. So, there is absolutely no question of power centre shifting from former to the latter. Even in an extreme scenario where all 3 nominees of the government follow his masters voice [unlikely as they are picked up by a search team in which RBI governor too has a say], the apex bank will eventually prevail in view of its 3 votes plus casting vote of the governor.
The other fireball [against the possibility of the government hijacking policy making] is that the minutes of MPC meetings will be in public domain thereby ensuring complete transparency in decision making. Knowing well that their actions will be under full public gaze, members will have to shun ‘arbitrariness’ and ‘subjectivity’ in their stances which need to be well explained and reasoned out.
Clearly, the apprehensions are without basis. Instead, we should be asking a question as to why a need was felt for moving away from subsisting arrangements? The state of the macro-economy depends on policy decisions in regard to fiscal deficit, taxation etc all taken by the government on one hand and the interest rate and liquidity on the other which fall within the remit of RBI. Hence, there has to be close coordination between the two.
But, this was missing under existing dispensation. There have been umpteen instances in the past when, the RBI governor walked alone fixing the policy rates ignoring the compelling needs for growth. Take the case of present chief.
During the first 16 months of his stint [September, 2013 to December, 2014], Rajan remained glued to high policy rate even as Modi – dispensation was creating all right conditions [expediting approvals, unclogging stuck projects, improving ease of doing business, reforming FDI regime etc] for extricating India from the low growth trap. That was the time for catalyzing such efforts via reduction in interest rate and providing more liquidity; yet he did not yield.
Successive governors have seen a connection between inflation and interest rate. That is almost like a religious belief. So, if inflation is high, they would like to keep interest rate high saying if it was lowered that would aggravate inflation. Rajan has carried that legacy and paved way for even higher rate regime by linking it to consumer price index [CPI] instead of whole sale price index [WPI] being the benchmark till that date.
Ironically, he did not reduce the policy rate even when CPI was ruling well below the benchmark set by none other than himself viz., 8% for January, 2015. Then, he justified this on ‘inflationary expectations’; those were imaginary. He gave too much weight age to drought disregarding good supply management unleashed by government. He also erred in reading of likely global price of crude oil which started its downward journey after reaching a peak in June, 2014. While, the economy needed growth impulse, he stuck to inflation targeting.
Since January, 2015, the reductions in policy rate [he did it 5 times leading to a cumulative cut of 1.5%] were literally forced on him with inflation remaining consistently low all through. This was in recognition of paramount need for high growth, pressure building on him from industry [especially small and medium enterprises] and even government keen on getting funds for projects unclogged via speedy approvals and clearances.
Now, with CPI moving up a bit in recent months, Rajan has given enough hints of truncating the rate reduction journey [this is despite the index still remaining below 6% target for January, 2016]. Thus, in bi-monthly review on June 7, 2016, he kept policy rate unchanged and in the next round too, he is unlikely to change the stance.
Rajan traversed alone keeping a tight leash on the rate [thus coming in the way of unleashing full potential of growth] because the existing dispensation gave him over-riding authority. With such sweeping powers gone, under MPC, India can look forward to more balanced outcomes that combine high growth with control on inflation.