Rediff.com  » Business » Govt vs RBI: Why new rules could lead to more controversies

Govt vs RBI: Why new rules could lead to more controversies

Last updated on: June 20, 2016 13:46 IST
Get Rediff News in your Inbox:

The Centre's move to change the functioning of the RBI, expected to put an end to the bickering between itself and the central bank, could yet spawn controversies, says A K Bhattacharya.

IMAGE: A reset in equations gives rise to many difficult situations and spawns controversies. Photograph: Reuters
 
 

Among the many equations the Narendra Modi government has reset with different stakeholders in the last two years, the one with the Reserve Bank of India (RBI) is the most significant.

To be sure, the process of resetting the relations between the central bank, including its governor, and the Union government had begun even before the Modi government had taken charge at the Centre.

But where it played a crucial role is in expediting that process and putting in place a permanent and formal structure of that new equation.

You may not always like or agree with the new equation or the structure, but there is now at least a new regime in place.

The first reset is with regard to the monetary policy framework. For the past several years, the idea that the central bank would enjoy necessary freedom in framing the monetary policy had gained acceptance more by convention.

The nature of that freedom, however, was not codified.

In the past, differences over the stance of the monetary policy or whether interest rates should be cut or not would often result in tense relations between Mint Road, where the RBI was headquartered, and North Block, where the finance ministry is situated. RBI governors and finance ministers have often had tense moments while dealing with such issues. 

Such bickering of the past should now be over, thanks to the framing of a monetary policy framework, which now has been legislated through amendments in the Reserve Bank of India Act. 

So, it has now been mandated by law that the RBI will operate the monetary policy framework.

The new law will certainly put an end to the bickering that in the past made front-page news.

But will it make RBI more independent and allow it to function as a regulator with necessary autonomy? A close reading of the new law raises many questions.  

The amended law, for instance, mandates that the RBI will “operate” the monetary policy framework, even as the government concedes that the objective of the monetary policy would be to maintain price stability while keeping in mind the objective of growth.

Note that the new monetary policy framework is largely the monetary policy committee that will be set up following the amendments to the RBI Act.

The RBI governor will chair this committee, which will have five more members - two of them will be from the central bank (the deputy governor in charge of monetary policy and a RBI officer to be nominated by the Central Board of the RBI) and three experts to be appointed by the government through a search committee headed by the Cabinet secretary. 

Will the governor have the power to have his say at the Committee’s meeting, whose advice on interest rates would be binding on the RBI under the law?

It appears so, as all its decisions will be taken with a majority vote and in the event of a tie, the governor will have a second vote or a casting vote. It will, however, require some effort every time the governor has to use his second vote to break the deadlock.

But who will decide the inflation target?

The new law says it is the government that will determine the inflation target in terms of the Consumer Price Index, in consultation with the RBI.

And the target will be reviewed every five years and would be gazetted through a separate notification.

It is important to note that the decisions on the composition of the monetary policy committee and on the setting of an inflation target every five years differ from the recommendations of the Urjit Patel Committee on the monetary policy framework.

The final and most significant reset in the relations between the government and the RBI is the manner in which the process of appointing the governor and deputy governors of the central bank has been changed.

Already, the RBI has lost its unique position among all financial sector regulators as the appointment of deputy governors is now being decided by a committee headed by the Cabinet secretary with the RBI governor as one of the members.

Earlier, deputy governors would be appointed through a consultative process involving the governor and the finance minister, which would then be approved by the prime minister.

It now seems that the government is following the same principle of allowing a committee of officials and experts to drive the process for appointing the next RBI governor.

It would be argued that the new appointment process is in line with the recommendations made by the financial sector legislative reforms commission and a committee-led selection procedure is better than appointing anybody through consultation.

But a reset in equations gives rise to many difficult situations and spawns controversies. This one will do both

Get Rediff News in your Inbox:
Source: source
 

Moneywiz Live!