Much debate has been generated with the revised draft of the Indian Financial Code, which has proposed an organisational change in decision-making with the introduction of a Monetary Policy Committee (MPC).
Recommendations for a Monetary Policy Committee to decide policy actions are not new. Such a proposal was first articulated (to the best of our knowledge) in 2002 by the Y. V. Reddy Committee, then in 2006 by the Tarapore Committee, the 2007 Percy Mistry Committee, then reiterated in the 2009 Raghuram Rajan Committee and then in 2013, both in the report of the Financial Sector Legislative Reforms Commission (FSLRC) and the Dr. Urjit R. Patel (URP) Committee. The latter two Committees have been the core of an ambitious exercise -- first, to transform India's relatively outdated welter of laws into a composite , integrated and modern structure, and the second, to harmonise the monetary policy framework with this. This article draws heavily upon both the URP Committee and the FSLR Commission reports.
"[T]he RBI Governor has hitherto had de-facto veto power on monetary policy decisions, and this is inimical to accommodating diversity of views in framing policy."
In India, although guided by internal inputs and of those received by the Committee of the Central Board of Directors of the RBI, monetary policy decisions are made by the Governor alone, and the quarterly (and now bi-monthly) policy statements are issued in his name. However, over time, the process of monetary policy decisioning has become more consultative and participative, and relies even more on external inputs. A Technical Advisory Committee (TAC) on Monetary Policy was established in 2005, but its role is purely advisory in nature.
Communicating the rationale of monetary policy actions is central to both the credibility of the central bank and to enable the incidence targets of the policy to adjusting behaviour appropriately. According to the URP Committee, "Heightened public interest and scrutiny of MP decisions and outcomes has propelled a worldwide movement towards a committee based approach to decision making with a view to bringing in greater transparency and accountability in India."
There is very little to disagree about the desirability of transitioning from the current decision process to that of an MPC, imparting as it does a greater diversity of views, specialised experience and independence of opinion. In addition, in line with the philosophy of FSLRC, process is at the centre of the change, and is one of the key reasons behind the formation of an MPC.
The controversy which was generated related to the composition of the MPC's members. Of the seven-member committee suggested by the draft IFC, four were to be appointed by a non-RBI body, which would tilt the decision process away from the central bank. However, subsequently, there have been clarifications from both the government and RBI that an agreement has been reached wherein the RBI and government would both have the right to nominate three members to the MPC, and the RBI Governor would be the chairman of the MPC, with a casting vote. This issue of the power of the RBI Governor also seems to have created some unease, which I think is largely misguided. Has the power of the Governor been diluted, not having had a veto power over the decisions of the MPC? As indicated earlier, the RBI Governor has hitherto had de-facto veto power on monetary policy decisions, and this is inimical to accommodating diversity of views in framing policy.
"While a range of external inputs, both advisory and binding, are an essential part of the process, the final monetary policy decision has to be made by the RBI."
How will these members be appointed to the MPC? The non-RBI members are to be appointed by a selection committee of experts from the field of finance, economics or law. What about the professional backgrounds and expertise areas of the members? The compositions of the Bank of England (BoE) MPC and the Federal Open Market Committee (FOMC) of the Federal Reserve System compositions are instructive. The current BoE MPC external members -- four -- are academics with experience in public policy and Government. The current 10 voting-member FOMC has three members with backgrounds in law and/or markets.
In India, the pool of experts from academia is likely to have a more limited spread and depth of expertise. There will be resources with an excellent academic oeuvre, but limited policy experience, and vice versa. Given the importance increasingly attached to inflation expectations formation and the incredibly rich social and cultural tapestry of India, a person with experience in behavioural sciences might bring rich insights to the process. Given the extent of government involvement in the economic sphere, a government official with deep fiscal expertise as well as operational experience of government decision making would bring the link between monetary, fiscal and industrial/trade policies.
In the final analysis, though, the central bank is the dominant, if not the sole, owner and custodian of the conduct of monetary policy, particularly if it is to be held accountable for achieving and maintaining an inflation target. While a range of external inputs, both advisory and binding, are an essential part of the process, the final monetary policy decision has to be made by the RBI.
Views are personal.