On Monday, the Union government started the process of setting up a new monetary policy framework when it announced the formation of a search panel for its nominees to a six-member committee, which will be tasked with deciding the rates at which the Reserve Bank of India lends, a key indicator that sets the benchmark for banks throughout the economy.
The government seems keen to put together the new committee by August so that outgoing governor Raghuram Rajan’s last policy review can go through it.
The amendments to the Reserve Bank of India Act, 1934, that were notified on Monday will essentially alter the way RBI has functioned so far.
At present, the RBI governor, in consultation with a technical advisory panel within the central bank, decides India’s monetary policy. But the governor has the power to veto decisions.
The new monetary policy committee will comprise three top RBI officials including the governor and deputy governor as well as the three government nominees. The RBI governor will not have veto powers, but will have the casting vote in case of a tie.
Main objective
The objective of the monetary policy committee is to maintain price stability in the economy, that is, rein-in inflation – something that Rajan focused on throughout his tenure and faced immense criticism for.
The government will set for the monetary policy committee an inflation target that will be permitted a variation of plus or minus 2 percentage points. If inflation strays above or below this band and the permitted variation for three consecutive quarters, the committee and RBI will have to concede monetary policy failure and explain the reasons behind it.
While one argument is that the new committee will dilute the autonomy of the RBI and make it prone to influence from the government or big business, outgoing governor Rajan thinks otherwise.
Aside from the back and forth regarding the composition of the committee for which the RBI was at loggerheads with the government, Rajan has largely been on board, and has even emphasised the importance of such a committee.
Indicating that six heads were better than one while forming policies that will have a wide-ranging impact on a billion people, Rajan said in March that a committee would be less prone to “undue pressure”.
“While the RBI governor will no longer be able to set monetary policy unilaterally, I believe shifting the decision to a committee is in the economy’s interest,” Rajan said during a lecture in Delhi. “Not only will a committee aggregate multiple views better than an individual can, it will offer more continuity and will be less subject to undue pressure.”
Importance of autonomy
C Rangarajan, former governor of the RBI wrote in the Hindu last year, that the new monetary policy framework was a “land mark in the evolution of monetary policy in our country”. He added that clarifying the objective of the Reserve Bank of India – inflation control – was a welcome step, which enhanced the bank’s autonomy.
At the same time, he argued against the majority being comprised of government nominees (that was one of the government's initial suggestions), saying that the committee's composition should enhance the RBI’s accountability not weaken it.
“Any mechanism that we create such as a Monetary Policy Committee should not weaken but, on the other hand, strengthen the hands of Reserve Bank of India to deal effectively with inflation,” he wrote.
There are expectations that Rajan’s last monetary policy review in August before his tenure ends in September will be signed off by the new committee and that should provide a good sense of the level of synchronisation between the central bank and the Finance Ministry.
