Before revamping mon pol framework, rethink governance at RBI first…

Just a while back, we were discussing how the government is interfering  in RBI’s affairs. There were talks of government threatening RBI’s independence by trying to meddle in functions of the central bank. So much so it forced the usually quiet RBI former governor to be quite vocal towards the end of his tenure.

Now post regime change in Sep-13, we are looking at a different problem. The issue now is how RBI is trying to undermine the Parliament by doing things as it pleases. It is even more surprising how there is no noise from either people in the Parliament (who understand what is going on and some do), media and experts. The same media which disliked the other institutions from getting into Parliament’s affairs (like courts, CAG etc) has been really quiet on this matter. Why should this  be?

The usually good Haseeb Drabu nails the issue:

With various committees constituted by the Reserve Bank of India (RBI) submitting their reports and recommendations, there is a discernible, if not yet decisive, move to change the monetary policy framework.  What is being recommended in these reports amounts to a change not only in the conduct of monetary policy but also the mandate of RBI.

This changes the context of the continued and unending debate on the autonomy of RBI that has been going on for the past three decades.  Until now the context was different. During the period immediately after economic liberalization, the autonomy of RBI meant having adequate headroom for operating monetary policy and giving it some flexibility.
For instance, C. Rangarajan’s strong pitch for greater autonomy of RBI in 1993 was hinged on ending automatic monetization of the government deficit. The change disengaged monetary policy from fiscal policy to some extent. But monetary policy continued to play second fiddle to fiscal policy.
All this while RBI was headed by people who reacted to this second fiddling role but they never tried to undermine the role of Parliament. Now it seems they don’t care.
Now the situation is different. Monetary policy is on its way to becoming an independent policy in its own right and not being a set of accommodating variables adjusting to fiscal policy. All the changes being proposed in the organizing structure, the operating framework and instruments of monetary policy can be dangerous. It is not inconceivable that the central bank can hijack the entire economic policy agenda set by an elected legislature. Indeed, the early signals are not very comforting.
The virtual acceptance of the Urjit Patel committee report by governorRaghuram Rajan in his monetary policy statement goes beyond matters of propriety. Or the fact that the Nachiket Mor committee report on microfinance doesn’t even mention the Micro Finance Institutions (Development and Regulation) Bill (2012), which is with Parliament for approval. This Bill covers the regulatory and supervisory aspects RBI will be engaged in.
Similarly, the suggestion of a parliamentary panel that RBI should not grant new banking licences to companies as the banking business is highly leveraged and involves public money, hasn’t even as much as got a reaction from RBI.
Are these cases of simple oversight or are these straws in the wind of pre-empting Parliament? RBI cannot and should not be seen to operate in a world of its own without due regard and recognition of what Parliament is doing or what the legislature is engaged in.

Time has come to look at this governance structure of RBI:

Pending a new RBI Act, reflecting all the developments in the financial and monetary sectors since 1934, there is a need to put in place a governance structure.

The only way to prevent RBI from either being a pooch or becoming a policy guerilla is a robust governance framework. 
That does not mean establishing a three-member monetary policy committee in the central bank. Indeed, in the current context it will give the government a handle to interfere more because it will influence the appointment of the committee members.
The starting point for a new governance framework can be the idea mooted by former governor D. Subbarao of going before a select committee of Parliament in an open manner as in the US and the UK to make regular presentations on the state of the economy and monetary policy.  As in the case of the US Federal Reserve, where the board is nominated by the President and approved by Senate, the RBI board must have a wider approval and consensus.
After the precedent set up in the appointment of the central vigilance commissioner and the Lokpal, the appointment of the RBI governor should be a unanimous decision by a committee consisting of the Prime Minister, the finance minister and the leader of the opposition.
It is funny that the Patel Committee report which borrowed so much from structures of Fed/BoE etc just ignored this aspect (on purpose?). In all these central banks, most appointments (especially the senior ones) are done by the Government amidst huge grilling by Senate/Parliament members. It also leads to jokes of how little the polity knows about central banking/economics but at the same time keeps the central bankers on their toes.  In India, it is a nearly a free ride for the top guys as no one really knows how they are appointed and why others are rejected.

There is a robust literature which talks about goal independence vs instrument independence.

  • Goal indep: All public institutions get their goals specified by the Parliament/Senate. The government also provides a broad framework under which the insti will act and also appoint major positions by itself.
  • Instrument indep: And then its upto the institution to use instruments/tools to achieve the specified goals.

In central banking parlance, this means government specifies the goals of the central bank (growth/inflation/unemployment etc) and central bank uses various tools (interest rates etc) to achieve the goals.

The experience of inflation targeting framework suggests (which RBI seeks) that most have been done with government taking the lead. The same should be the case here as well. Earlier, there were threats of government getting into RBI’s instrument independence (which is usually the case) and now it seems RBI wants goal independence as well..

The problem is RBI is in a real hurry and one does not know why. And government is clueless on what to do. And we have even a worse timing of elections looming. RBI seems to be taking this opportunity by pushing things as no one is looking or does not have time to look.

This is all dangerous as a new government might have a different take. If the former government has agreed on certain proposals then the new government can do little. But if the RBI the policy guerilla has changed things, it might force changes. And then there will be the usual chaos.

Drabu ends saying:

Before changing policies or the mandate that it has, RBI will do well to focus on restructuring the institutional and organizational setting in which it is going to pursue its “new monetary and financial policy”, not the policies themselves.

 I would say the government should take lead and restructure things and specify the goals clearly. But then as we are running into elections, it has other priorities. The usually sensible RBI should wait and seek government’s approval for all these changes. Actually the FSLRC has specified much of these changes but somehow RBI does not want to wait. Creating hype has become RBI’s mantra in recent times.

Common sense should prevail over aggression..Even more puzzling is how quiet the experts are on this matter…

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