Is The Government Trying To Deflate The Power Of RBI Governor? - Outside View by PersonalFN

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Is The Government Trying To Deflate The Power Of RBI Governor?
Jul 4, 2016

Personal biases can affect the decision making of an organisation. Therefore, any effective organisation establishes various departments, assigns authorities, and fixes responsibilities. Within departments and across departments there are committees that take crucial decisions. Committee members are often selected as per their competence and experience keeping in mind the overall team structure. This saves a company from the pitfalls of misjudgement of an individual. This is not to say that heads of institutions are incapable of making important decisions, but if they miss out on the important things that may have a bearing on their decisions, other members in the committee can register their views. In brief, democratic organisations are more effective than autocratic organisations.

Recently, India has taken a step forward in making the functioning of the Reserve Bank of India (RBI) more democratic.

The role of central banks is getting critical day by day with globalisation of local problems. In a developing country like India, the role of the central bank is even more difficult. It has to strike a balance between growth and inflation. Often, in an attempt of spurring the growth by lowering interest rates, countries end up pushing the inflation much higher than they can handle.

In India, the RBI takes the call on interest rates based on the performance of pre-set economic indicators. It also tries to maintain the exchange rate stability in phases of extreme volatility. It oversees banks and also manages Government debt. Until now, the RBI Governor was the sole decision maker, however, as far as decisions on the monetary policy are concerned, the Governor is going to lose powers. Now the Committee will take decisions pertaining to the monetary policies.

Recent development...

Recently, the Government of India decided to constitute a Monetary Policy Committee (MPC) under the Reserve Bank of India Act, 1934.The amendments to the said Act will be enforced with immediate effect. With this, the Government has moved a step closer to providing the statutory and institutionalised framework for an MPC.

So, is the dilution of the powers of RBI's Governor good or bad?

There can't be a one word answer to this. There are merits as well as demerits of having a committee taking monetary policy decisions instead of the RBI Governor being solely in charge.

Central Banks in many countries that don't follow the inflation-targeting approach (such as that of the United States), hold the Board of Governors and Open Market Committees responsible for policy decisions. On the other hand, many among those following the inflation targeting approach, have MPCs in place for making decisions. Alternatively, the Board takes policy decisions based on the recommendations of the MPC.

Therefore, taking into consideration the international scenario, a consensus building seems to be the right decision given the complexities involved in decision making these days.

What are the merits of having MPC for deciding the policy direction?

  • Helps capture more information and perspectives leading to a balanced and well-thought through conclusions
  • It's a great risk management method for reducing errors of judgment in deciding the policy direction
  • Protects and promotes receptiveness and independence of the opinion of all stakeholders

However, what may probably be the matter of dispute is -representation to the Government in MPC. Internationally, barring a few countries namely Colombia, Guatemala, and the Philippines, hardly any other country follows a practice of giving the Government representation in the MPC.

What are the potential demerits?

  • Unless all members of MPC actively participate in the decision making process, there would be lack of efficiency in decision making
  • Unless the team composition is right, a committee approach may lead to group thinking, which in turn could limit the benefits of having a committee to decide monetary policy direction

The MPC will comprise of...

As the Government stated, the MPC will be a 6-member committee and will provide equal representation to the Government and RBI. Meaning, the RBI will send its 3 members to the committee that will be comprised of the Governor, Deputy Governor, and one officer of RBI. The Central Government will appoint another 3 members based on the recommendations of the Search-cum-Selection Committee headed by the Cabinet Secretary. MPC will meet at least 4 times in a year. The committee through voting will decide the policy rates. Each member of the committee will have one vote and the RBI Governor will have an additional vote which he can exercise in case of a tie.

Since India follows the inflation-targeting approach, the Committee will be held responsible and accountable for meeting targets. The Committee would be considered to have failed in achieving the objectives only if the average inflation for 3 consecutive quarters crosses the tolerance limits on either sides. However, the inflation target hasn't been notified yet.

Will the MPC approach be successful in India?

Considering the powers of the committee and its impact on the Indian economy, it's extremely important that the selection of the committee would be impartial. Historically, there have been differences of opinion between the Government and RBI. When Mr P. Chidambaram was the Finance Minister, he batted for lower interest rates and many times contradicted the RBI's stance on policy rates. Mr Arun Jaitely, his successor, has been following the same approach.

As the Committee will have 3 members representing the Government, there're likely chances that, all of them may have the same opinion about the movement of interest rates in the economy. On the other hand, all RBI representatives may have the same opinion. In such a case, the RBI Governor would hold the key as he has one additional vote to cast in case of a tie. Unless, we get a flexible and truly impartial Governor, the MPC may not achieve great success in India.

Dr Raghuram Rajan is not a "Yes Sir" person. If the RBI gets a proponent of a particular school at the helm, it is unlikely that the MPC will be as effective as it is expected to be. PersonalFN believes, a pro-Government Governor would weaken the RBI as an institution, and an inflexible leader may find it difficult to bridge the gap between the RBI and Government.

Of course both institutions have denied having any rift between them, but intelligent observers have identified and experienced the difference of views that prevails between India's two powerful forces from time to time.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


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