The government and RBI are in the process of finalising the structure of India’s Monetary Policy Committee. In this article, Amartya Lahiri, Professor of Economics at the University of British Columbia, makes recommendations for the composition of the committee that would help preserve the independence of the RBI in monetary policy oversight and conduct in form and spirit.
second draft of the Indian Financial Code (IFC) that was circulated on July 23,
2015 was widely perceived as the government trying to curtail the independence
of the Reserve Bank of India (RBI) in determining the course of monetary
policy. The media discussion regarding the proposed structure of the Monetary Policy
Committee (MPC) has focused on two aspects: composition of the committee; and
veto power for the RBI governor over MPC decisions. Specifically, the revised
draft proposed that the seven-member MPC, which would choose monetary policy in
India through a majority vote, be composed of three members from the RBI and
four government nominees. Moreover, the revised draft did not give the RBI Governor
(renamed the Chairperson, for somewhat unclear reasons) veto power over the
committee’s decisions, as opposed to the initial draft.
going into the specific arguments, it is important to point out that the
recommendation that monetary policy decisions be handed over to an MPC actually
originated from the RBI itself as part of the report of an expert panel headed
by Deputy Governor Urjit Patel. This panel was set up by Governor Raghuram
Rajan himself and tasked with conducting a root-and-branch review of the
monetary policy framework in India. Hence, the headlines that the government is
trying to neuter the RBI by proposing a committee and not giving the Governor a
veto is entirely off-base. The Patel committee proposed an MPC and didn’t
recommend a veto for the Governor either.
Veto power contradictory to committee approach
reasoning behind the panel’s recommendation that monetary policy be conducted
by a committee was that an MPC would minimise the chances of a bad/wrong
decision due to the wrong judgement of any one person (the Governor), however
well-intentioned he/she may be. This is widely accepted globally and is the
reason why most central banks take monetary policy decisions through committees
rather than vesting them in the hands of one person. In light of this, the
current debate should not be couched in terms of whether or not to have a
committee. The answer to that is fairly clear. Rather, the focus is, and should
be, on the optimal design of the MPC.
Before discussing the design of the
committee, it is useful to address the issue of a veto for the RBI Governor.
Since the logic for handing over monetary policy decisions to a committee is
mainly to avoid the pitfalls of dictatorial decisions by an individual person, handing
the Governor a veto over MPC decisions would be remarkably self-defeating.
Indeed, Rajan himself has come out against the idea of giving the Governor a
veto. Few central
banks with a committee approach give the committee chairman such a veto.
Composition of the committee
The key issue then is the composition of the MPC. Given
that one of the primary goals of the proposed reform is to provide the RBI and
the MPC with independent jurisdiction over monetary policy subject to the
government and the RBI agreeing on the precise inflation target, the originally
proposed seven-member committee with four government appointees attracted a lot
of criticism and debate. Some of this criticism was well-placed. Handing a
majority of MPC seats to government nominees creates a potential situation
where the government could dictate monetary policy (if its nominees collectively
choose to do the government’s bidding). This particular situation would be akin
to handing the government a ‘tails I win, heads you lose’ instrument since it
could choose the monetary policy it desires and yet blame the RBI if the agreed
upon inflation target is not met.
There are two approaches that might provide a
simple solution. The first would be to have a seven-member committee with three
RBI members, two nominated by the government and two outsiders to be nominated
either by the RBI or jointly by the RBI and the government. The second would be
to have a six-member committee with three RBI and three government nominees
with the Governor of the RBI, in his/her capacity of being Chairperson of the
MPC, having a casting vote. That way we can have a committee with the
independence of the RBI in monetary policy oversight and conduct being
preserved both in form and spirit. It seems that the negotiations between the
Finance Ministry and RBI are likely to arrive at this latter solution.
A final word is possibly in order regarding the
choice of the government and outside nominees. In India, memberships in expert
committees often end up being routinely handed out to retired bureaucrats. The
point of a committee is to have the benefit of opinions of people from diverse
backgrounds with specialisation that is relevant to the task of the committee. It
may be worthwhile building in safeguards to prevent the MPC from becoming a
parking space for career bureaucrats, past and present.