As India moves towards the implementation of an inflation-targeting mechanism, the debate about the structure of this policy has intensified. To date, monetary policy has been the exclusive domain of RBI, and within RBI, under the exclusive and sole discretion of the Governor. To be sure, the central bank has a large and competent staff which feeds inputs to the Governor. In addition, the Governor has a seven-member Technical Advisory Committee, composed of non-RBI experts, who deliberate, and recommend, monetary policy, including Repo rates, to RBI. However, RBI is not bound to the TAC recommendations. In this regard, the RBI Governor has complete and absolute authority on monetary policy, as do his counterparts in Latin America (e.g. Brazil, Chile, Mexico), and New Zealand—a partial listing of countries where the central bank Governor has absolute authority.
In March 2011, the UPA government appointed a nine-member Financial Sector Legislative Reforms Committee (FSLRC), under the chairmanship of former Supreme Court judge, Justice Srikrishna. The committee was to decide on various regulatory aspects of Indian financial institutions, including RBI. Srikrishna had just completed (in June 2010) his tenure in a committee on the bifurcation of the state of Andhra Pradesh, which eventually did happen in 2014.
UPA finance ministers (P Chidambaram and Pranab Mukherjee) consistently had problems with the RBI Governors. Possibly because of these strained relationships, the FSLRC seemed to endorse the view that RBI wings needed to be clipped, and then some. In the first FSLRC report (March 2013) the proposal for monetary policy implementation was as follows: “the creation of an MPC that would determine the policy interest rate. In addition to the Chairperson and one executive member of the board, the MPC would have five external members. Of these five, two would be appointed by the Central Government, in consultation with the Chairperson, while the remaining three would be appointed solely by the Central Government.” However, FSLRC’s version 1.0 did allow the RBI Governor to have veto power in the MPC decisions under “extreme circumstances”.
Version 1.0 was a mixture of vote and veto—2 members from RBI (Governor & Deputy Governor for economics & monetary policy, two external members selected by Governor and 3 selected by the Centre. All five would, however, formally be appointed by the Centre (read ministry of finance, or MoF). Implicitly, four of the five external members of the MPC would have to agree to a course of action different from the Governor to override him. Subsequently, RBI’s Urjit Patel committee’s report in January 2014, recommended an MPC with a difference balance. The report advocated inflation targeting along with an MPC, and the latter was to be constituted as follows: “The Governor of the RBI will be the Chairman of the MPC, the Deputy Governor in charge of monetary policy will be the Vice Chairman, and the Executive Director in charge of monetary policy will be a member. Two other members will be external, to be decided by the Chairman and Vice Chairman on the basis of demonstrated expertise and experience in monetary economics, macroeconomics, central banking, financial markets, public finance and related areas.” This report was noteworthy for the fact that it would be near identical in power structure to the present, no MPC structure, i.e., RBI in control. Even if both the external members of the MPC disagreed with the Governor, he would always have at least a 3-2 majority.
On July 23, FSLRC responded with its version 2.0 of the MPC, which would comprise of 3 members of RBI (instead of 2 before) and four external members nominated by the MoF—and no extreme circumstances and no veto power! This recommendation goes against almost any definition of an independent central bank—and in our view, will not be acceptable to the MoF or the government.
The table lists the practice of monetary policy in 15 selected countries. As is well known, the US system of setting rates is via “consensus”, with 7 of the 12 FOMC members being selected by the President and ratified by the Senate. The other 5 rotational members are regional bank heads and are therefore (implicitly) appointed by the central bank.
Version 2.0 is comparable to a few of the selected countries—e.g. Korea, Norway, Philippines. While some parts of the media have suggested that the Indian structure is similar to Thailand, that is not the case; while Thailand does have a 7-member committee, all 7 members are appointed by the Central Bank.
Our first proposed structure (and the one we really prefer) is that the MPC be a formal 5- (7-) member body with the Governor as chairman and four (six) outside professional experts as members. The tenure of each member should be 5/7 years. The experts cannot be employees of either RBI or the government of India. All four (six) members must have knowledge and expertise in macroeconomics and monetary and/or fiscal policy. The government will have the right to suggest a list of names for the consideration of RBI, but the Governor will have the right to choose and appoint those he wants, subject to the above criteria. The decisions of the MPC will however be binding on the Governor. This means that if and only if three (four) of the four (six) independent members of the MPC agree on a policy course different from that proposed by the Governor, would the Governor be obliged to accept their decision.
Israel seems to have the best mix among the existing systems. The Governor chairs the MPC consisting of 6 members, with three outside members selected by the government. In case of a tie, the Chair has the deciding vote (not clear on Israeli central Bank website). This is our second proposed structure of the MPC, based on the best in emerging market practice. Again, we would recommend a 5-/7-year term.
Regardless of which of our proposed structures is adopted, we want to emphasize that it is important that RBI have both the responsibility and accountability of monetary policy. It should also be, and seen to be, independent of the government of India. Finally, accountability of RBI would mean twice a year presentations (and grilling!) by parliamentarians, not unlike the practice in the US. The latter, of course, cannot happen if the parliament is not allowed to function!
Bhalla is chairman, Oxus Investments, and senior India analyst for Observatory Group, a New York-based macroeconomic policy advisory firm. Virmani is former executive director, IMF, and former chief economic advisor, ministry of finance
