The Union government has proposed to strip the Reserve Bank Governor’s veto vote on India’s monetary policy
The government has released a draft version of the Indian Financial Code (IFC), which details various aspects of financial sector legislation including the monetary policy committee (MPC), public debt management, new regulatory architecture, among others. The key proposals on monetary policy are as follows:
(a) Composition of the MPC: As per the draft IFC, the MPC will comprise seven voting members, of whom three will be from the RBI (Reserve Bank of India Chairperson, RBI executive member, RBI employee) and four external members, who will be appointed by the central government for a term of four years. In addition, the government will also nominate a non-voting representative to attend all MPC meetings. This is in contrast to the Urjit Patel Committee (UPC), which had recommended a five-member MPC comprising three RBI members (majority) and two external members, who would be decided by the RBI Governor and Deputy Governor. Therefore, the draft IFC suggests that government-appointed members will be in the majority, a significant dilution of the RBI’s powers. It is to be noted that, in most countries, the government does not have representation in the MPC (except in Colombia, Guatemala and the Philippines). Among inflation-targeting countries, about half have no external members in their MPCs.
(b) Inflation Target: CPI inflation would be the inflation target. However, the draft IFC does not give a precise numerical target and instead states that the target CPI (and the inflation band) would be decided by the RBI and government every three years. The UPC had recommended a target of 6% by January 2016 and thereafter of 4% (+/- 2%). In line with this, the RBI and government had signed a monetary policy framework agreement in February 2015 (India: New Monetary policy framework formalised, March 2, 2015).
(c) Voting: Policy rates will be determined by a majority vote with one vote per member. In the event of a tie (when one person is absent; quorum is five), the RBI chair will have a second and casting vote.
(d) Accountability: In the event of failure, the RBI will have to report to the central government explaining the reasons for inflation over/undershooting its target, the remedial actions and the time horizon within which the inflation target will be achieved.
(e) Transparency: Similar to the UPC recommendations, the draft says that once every six months, the RBI will have to publish a report with its inflation forecast for the following 6-18 months. Additionally, the minutes of the MPC meetings will be published on the 14th day after the MPC meeting and a detailed transcript will be made available three years after the meeting.
According to media reports, the Union government has proposed to strip the Reserve Bank Governor’s veto vote on India’s monetary policy. The government also proposed to grant itself the power to appoint four of the six members of the Monetary Policy Committee, whose remit will include decisions on setting interest rates to maintain inflation at the targeted level.
The revised draft of the Indian Financial Code, put out by the Union Finance Ministry for comments, proposes that the Reserve Bank “Chairperson” shall head the committee, with no reference to the Governor. It is not clear from the draft if a re-designation is planned. Under the revised draft, the non-government members of the committee are to be drawn from the Reserve Bank.
Nomura Securities, in its research note, has forecast the following implications of the change in government policy: At the outset, the draft IFC appears to have diluted the monetary policy framework that the Urjit Patel committee had recommended. While a lot will depend on the choice of MPC members, a clear majority for central government appointed members on the MPC is clearly a dilution of the RBI’s independence in executing monetary policy. Historically, governments tend to have a growth bias and hence, if implemented, this could lead to a more dovish outcome, even more so as the government will not be accountable in the event of failure to meet the inflation objective. For the RBI to be accountable without having a majority in the MPC could eventually compromise the efficacy and credibility of the central bank, and hence Nomura does not view this as a medium-term positive. This is a draft version and the government has invited public comments by 8 August 2015. Given that the monsoon session would be wrapping up by then, it is more likely that the final IFC will be taken up for discussion in the winter session of Parliament.