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A plot to destroy RBI - Outside View by S.S. TARAPORE

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A plot to destroy RBI
May 3, 2013

The Financial Sector legislative Reforms Commission (FSLRC) claims that it has set out a new legislative structure which would meet the requirements of the future.

It is not enough for the Commission to be convinced that the reform is for the general good; all major economic agents should be convinced that the revamp is in the best interests of the country.

Unfortunately, the Commission's Report reeks of an anti-Reserve Bank of India (RBI) bias. The FSLRC game-plan is to vivisect the 'RBI' and after dismembering it, talk about independence and accountability for objectives which would be set for it by the government!

Commission's agenda

Institutions which are not His Master's Voice should first be destroyed, which would enable the setting up of an obedient edifice. Given this backdrop, it is no surprise that the RBI is the central target for attack.

The clever ploy is to argue that the RBI has too much on its plate which creates a conflict of interest and hence the rationale for dismemberment: Public debt should be taken away from the RBI without any preconditions on fiscal consolidation. Non-banking finance companies should have no place in the RBI firmament.

The RBI should be stripped of its role in financial markets, and capital controls should be vested with the Ministry of Finance (the very strong notes of dissent by Malegam, Udeshi and Nayak need to be noted).

Grudgingly, the Commission leaves banking regulation and supervision, and the payments and settlements system with the RBI, but only for a temporary period.

Proposed Structure of RBI

The Commission envisages a 12-member RBI Board with not more than one half being executive members; this by itself is reasonable but one has to dwell a little further into the Commission's proposal. There is an insidious proposal, in that the post of 'Governor' should be abolished and the head of RBI should be named as 'Chairperson'.

The Commission's ready defence would be that, after all, the head of the US Fed is called 'Chairman'; the Commission would conveniently forget that members of the US Fed are called Governors and the head is known as Chairman of the Board of Governors.

Furthermore, the Deputy Governors are to be brought down a peg and called members and one of the members would be called an 'administrative law member'.

The whole ploy seems to be to downgrade the RBI to the level of any other financial regulators. The Commission needs to appreciate that central banks are unique.

Monetary Policy Function

The Commission emphasises the need for independence of the central bank with accountability. It is argued that the central bank must be given a quantifiable monitorable objective by the Government for its monetary policy function.

The Commission discusses the broad international consensus on price stability as the clear focus of the central bank but backs off from such a recommendation.

The setting of objectives would be by the Government in consultation with the RBI.

In fairness, the Commission refers to a predominant objective and secondary objectives, which would be prioritised and subject to the predominant objective being delivered. The Statement, which would be issued every two years, would also specify what would constitute a substantial failure.

Illustratively, the Government could prescribe a predominant objective of, say, a 10 per cent per annum real growth and secondary objectives of 20 million new jobs per annum and a 3 per cent per annum inflation rate.

The RBI could be given an impossible task and made the whipping boy for the Government's own failure.

Any credible setting of objectives should follow the assignment rule of a policy being required to attain the objective it is best suited to deliver and, by this token, the predominant objective should be price stability.

If the polity is unwilling to give price stability the predominant objective, a second best option would be for the RBI to be allowed to set out the objectives which would then be discussed with Government and, in case the Government uses an override, the RBI objectives and the override should both be placed in the public domain.

Devil in the detail

The Commission recommends the setting up of a statutory Monetary Policy Committee (MPC) to take executive decisions on monetary policy with each member having a vote and the Chairperson having a veto, which must be explained with a public statement. The devil is in the detail.

There would be only two RBI members and five external members appointed by the Government. The Ministry of Finance nominee would be a non-voting member on the MPC but would articulate the Government viewpoint.

With Big Brother watching over their shoulder, brave would be the external member who would deviate from the Government line. The RBI would be better off with the present arrangement.

The leitmotif of the FSLRC is to charge the gate of the temple of money with iconoclastic fervour. One prays that in this internecine battle, the RBI's Pretorian Guards fight off the charge of the Commissioners.

One must remember that countries that destroy their central banks destroy themselves.

The Financial Sector Legislative Reforms Commission wants to restructure, or effectively dismember, the RBI by arguing that it has too much on its plate.

Please Note: This article was first published in The Hindu Business Line on May 03, 2013.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

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The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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2 Responses to "A plot to destroy RBI"

Capt. Ahuja

May 12, 2013

Govt wants to make it a "caged parrot". There should be strong protest against it, if it happens. Thx

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Dr Rajeev Kapur

May 9, 2013

Interesting observation. RBI has done well and has been appreciated all over the world for its handling of economic issues. India has emerged relatively unscathed when USA and Europe are reeling under recession is ample proof of RBIs success. Only a corrupt and foolish government can breakdown and downgrade such an institution.

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