Micromanaging financial institutions can backfire

The rockstar central banker Dr Raghuram G Rajan and an equally debonair finance minister Arun Jaitley appear to be in for tough time. Both have to grapple with some serious issues of economic management. Despite reports to the contrary, Rajan and Jaitley have outrightly dismissed speculations of simmering differences between them that could lead to a showdown. 

Although issues such as inflation-targeting as part of monetary policy overhaul and separation of public debt management from the central bank to a new agency were mutually agreed upon, the changes sought to be incorporated into the Finance Bill 2015 to pave the way for creating a deeper bond market have irked the RBI. Following the central bank’s reluctance, the proposal has been put on hold. Analysts contend that had the proposal been implemented, the regulation of the interbank bond market, a crucial part of liquidity/monetary management, would have been wrested from the RBI to benefit the market regulator the Securities and Exchange Board of India (SEBI) in getting additional leverage on this score.

On February 20, the mandarins in the apex bank and the finance ministry signed the Monetary Policy Framework and adopted inflation-targeting for the economy. Under this pact, the RBI is committed to reduce inflation to below 6 per cent by January 2016 with a target of 4 per cent with a band of plus/minus two per cent for 2016-17 and all the subsequent years. The pact also provides for a Monetary Policy Committee (MPC), which will put in place a monetary strategy to calibrate policy rates, thereby deviating from the current practice where the RBI governor is informally assisted by bank officials and external advisers. The bone of contention here is not inflation-targeting but the composition of the MPC — how many of them would be government nominees and bank representatives — and whether the RBI governor can wield veto power in case he clashes with majority opinion. Inflation targeting is now 25 years old in New Zealand which implemented this concept. Other rich and emerging economies, including Brazil, followed suit. The 2008 financial crisis and the subsequent phase of cheap money policy had not helped in stoking demand with low inflation and negative interest rates in advanced countries. This meant inflation targeting has all but been declared dead or buried! In the case of Brazil, the authorities battled hard to hit the official target as the government followed an expansionary fiscal policy for electoral gains. 

For India, the worst of inflation may well be over, thanks to a dramatic drop in global crude prices. But a return of inflation can’t be ruled out, particularly, in the wake of a truant monsoon as well as the constraints of transporting food items to markets. That is precisely the reason why Jaitley went for massive public investment in infrastructure in the Budget which also holds the danger of stoking inflation. The success or failure of inflation-targeting depends a lot on how quality fiscal policy is put in place so that the central bank’s task does not get out of kilter.

The RBI governor seems to have reconciled with the idea of a separate Public Debt Management Agency, though with a rider. Rajan has said that “a public debt management agency as a professional organisation, independent of the central bank, independent of the government is something that is desirable”. How this autonomy is to be secured for the new body is anybody’s guess when the central bank is well aware that its own autonomy is being eroded with the government meddling even in the bank’s core monetary policy. Policy wonks have already expressed their disapproval of government micromanaging institutions of integrity such as the RBI.

The author is a Delhi-based journalist