X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Is The Government Trying To Deflate The Power Of RBI Governor? - Outside View by PersonalFN
  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

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.

Disclaimer:

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.

Equitymaster requests your view! Post a comment on "Is The Government Trying To Deflate The Power Of RBI Governor?". Click here!

  

More Views on News

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

You've Heard of Timeless Books... Ever Heard of Timeless Stocks? (The 5 Minute Wrapup)

Aug 19, 2017

Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.

Why NOW Is the WORST Time for Index Investing (The 5 Minute Wrapup)

Aug 18, 2017

Buying the index now will hardly help make money in stocks even in ten years.

Trump Takes a Beating (Vivek Kaul's Diary)

Aug 18, 2017

Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.

How To Read Your Mutual Fund Account Statement Correctly (Outside View)

Aug 17, 2017

PersonalFN simplifies the mutual fund account statement for you.

More Views on News

Most Popular

Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

Aug 7, 2017

The data tells us quite a different story from the one the government is trying to project.

A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

Aug 10, 2017

Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

Aug 8, 2017

Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

Signs of Life in the India VIX(Daily Profit Hunter)

Aug 12, 2017

The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

Aug 7, 2017

Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

More

Become A Smarter Investor In
Just 5 Minutes

Multibagger Stocks Guide 2017
Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Aug 18, 2017 (Close)

MARKET STATS