At first glance, the revised draft of the Indian Financial Code released last week, 853 days after the Financial Sector Legislative Reforms Commission (FSLRC) published the first draft, seems to be a balancing act.
It has recommended substantial dilution of the powers of the proposed Financial Sector Appellate Tribunal (FSAT). This will replace the existing Securities Appellate Tribunal and entertain appeals against all financial sector regulators, including the Reserve Bank of India (RBI), but won’t have the powers to set aside any regulations which the first draft had envisaged. This is good news for the Indian central bank, but the not-so-good news is the composition of the monetary policy committee or MPC that it has proposed.
The latest draft gives the Union government the right to appoint four out of seven MPC members. It also takes away the veto power of the RBI governor even as he will have a casting vote in the event of a tie in the MPC (which can happen if one member is absent at the meeting).
A January 2014 report on revising and strengthening the monetary policy framework by RBI deputy governor Urjit Patel had recommended a five-member MPC with the governor as the chairman, the deputy governor in charge of monetary policy as vice-chairman, and the executive director in charge of monetary policy as a member. Even the two other external members, according to the Urjit Patel report, should be picked up by the chairman and vice-chairman on the basis of their expertise and experience in monetary economics, macroeconomics, central banking, financial markets and public finance. Overly tilted in favour of RBI, this report also suggested that the governor and, in his absence the deputy governor, will have a casting vote in case of a tie, but it was not in favour of the governor enjoying the veto power.
The idea of the veto power of the governor was mooted by the original report of the FSLRC which had spoken about a seven-member MPC, chaired by the RBI governor. While one member will be from the RBI, five independent experts in the field of monetary economics and finance will be appointed by the Union government, it had suggested. Of the five, the appointment of two members will be in consultation with the governor. It had also said that a representative of the central government, without having any voting rights, would participate in the MPC meetings to express the views of the finance ministry. The revised draft has changed the representation of RBI: government ratio in the MPC from 2:5 to 3:4 but dropped the proposed veto power of the governor.
This has sparked off a debate on the government maiming RBI and enjoying a greater say in the making of India’s monetary policy. The fear is politicization of the process as the members chosen by the government are expected to toe the government line, which often has short-term views on growth and inflation.
Let’s take a look at how the central banks in the developed markets work on monetary policy. In the US, the Federal Open Market Committee or FOMC decides on the Fed funds rate. Indeed, its seven board members are appointed by the president but their appointments are ratified by the Senate. And, there are instances of the Senate rejecting the president’s nominee. For instance, in August 2010, the US Senate scrapped the nomination of MIT professor and an expert on taxes and social security, Peter Diamond, to the Federal Reserve Board. There are five more FOMC members who are regional reserve bank heads, taking the total number to 12, each having one vote. The Bank of England’s monetary policy committee has nine members, including the governor, three deputy governors and the chief economist of the central bank. UK’s chancellor appoints the rest, who are independent. A member of the Treasury is allowed to attend the meetings and join the debate but doesn’t have a vote. The European Central Bank has a larger committee to decide on interest rates, consisting of six executive council members with permanent voting rights and 19 representatives from member states.
The fight between the finance ministry and RBI on the central bank’s so-called autonomy is not new. Rajan’s predecessors D. Subbarao and Y.V. Reddy had pitched battles during their tenures. While Reddy’s run-ins with the finance ministry were more on specific issues, Subbarao fought over broader policy issues. Many believe that RBI lost the battle for autonomy to the ministry of finance when Parliament passed the regulatory dispute resolution bill, paving the path for the creation of the Financial Stability and Development Council. Ahead of that, an 18 June 2010 ordinance empowered the finance ministry to resolve all disputes between the regulators, prompting then governor Subbarao to write to the finance minister, saying “the appearance of autonomy is as important as the actual autonomy itself”, and “the very existence of a joint committee (the council) will sow seeds of doubt in public mind about the independence of regulators”. The governor urged Pranab Mukherjee, then finance minister, to “allow the ordinance to lapse” but Mukherjee did not oblige him.
Even if the government enjoys the power of appointing four of the seven members of the MPC and the RBI governor does not enjoy the veto power, there’s nothing to worry about as long as the credentials of the members are impeccable and they are not serving government officials. Since the minutes of the MPC meeting will be made public, the government will be exposed if it plans to push its agenda through its nominees. Also, not the governor alone but the entire MPC will be held accountable if the inflation target is missed. This means everybody will have a stake and credibility to defend. The new set-up will not dent RBI’s autonomy, but even before it is put in place, the finance ministry should stop expressing its opinion on interest rates.