Having agreed this week to formally adopt inflation targeting as a guiding star for monetary policy, the Narendra Modi government and the Reserve Bank of India (RBI) remain at odds over how crucial decisions are made.
Both sides support the setting up of a Monetary Policy Committee, as first officially proposed in 2014 when a different government was in power, and Reserve Bank of India (RBI) Governor Raghuram Rajan was just four months into the job.
But, say officials with knowledge of the various proposals, the two sides disagree over everything else — the size of the committee, its composition and whether the central bank chief would have the final say, in the form of a veto.
“There is no convergence,” said one senior policymaker familiar with the issues.
Rajan triumphed this week by binding Prime Minister Narendra Modi’s 10-month-old government to a monetary strategy built around inflation targeting, following a trend at other major central banks in both developed and emerging market economies.
And on Wednesday, just days after the government presented its first full budget, the RBI unexpectedly lowered its policy rate for the second time this year, backing efforts to revive growth as inflation cools.
The RBI governor, who takes advice from his deputies and a panel of external advisers, said the external advisers were not consulted for the latest rate cut.
Going forward, Rajan, a defender of central bank independence and former International Monetary Fund chief economist, will have to seek common ground with a government that wants its own appointees to have a role in deciding rates.
“Conflict between the RBI and finance ministry cannot be ruled out,” said one finance ministry official.
Currently, there appears to be harmony on the big issues. After ministers welcomed Wednesday’s RBI rate cut, Rajan gave cautious support for the 2015/16 budget presented by Finance Minister Arun Jaitley days earlier.
“This is a good beginning and we are going to be watchful,” Rajan said.
Holding onto operational independence could be easier for Rajan when things are going comparatively well. For now inflation is falling, the current account deficit is nowhere near the parlous state it was in 2013, the rupee is stable, and the economy, while weak in parts, is picking up momentum.
POLITICS OF COMMITTEE-MAKING
Monetary policy committees have become the norm among major central banks in the world, but how one would work in India is still uncertain, as officials have only held preliminary discussions of proposals.
The government will need to pass through parliament an amendment to the RBI Act to clear any changes to the central bank’s objectives, officials said.
Any signs of government influence in the central bank’s decisions would worry investors, given India’s history of high spending, which if accompanied by low interest rates could lead to a surge in inflation and deepening debt problems.
“A government’s active role in monetary policy-making risks undermining the central bank’s independence and might result in conflict of interests in terms of broader economic priorities,” said Radhika Rao, an economist at DBS in Singapore.
Investors recognise the merits of reducing the influence of a single individual, even one as trusted as Rajan, and would welcome change at an institution regarded as conservative and hierarchical.
But they wouldn’t want to see India’s central bank coming under the kind of political pressure suspected of taking place in South Korea and Indonesia, for example, or suffering a controversy like one presently gripping Turkey.
Although the RBI is not statutorily independent, as the governor is appointed by the government, it currently enjoys broad autonomy in setting rates.
Things could be different once an MPC is established.
A panel appointed by the central bank has proposed a five-member committee, composed of the RBI Governor, the deputy governor, a central bank executive director and two external members picked by the central bank.
A government-appointed commission, however, has recommended a seven-member panel composed of the RBI Governor, an executive member of the RBI board, along with five external members picked by the government, of which two would be selected in consultation with the RBI.
In addition, the government would send a non-voting representative to policy meetings. The commission also recommends that the RBI governor gets veto power over the committee’s decisions though it should be followed by a public statement.
Some government officials oppose giving the governor veto power, however, while many in the RBI view it as essential if government-appointees are included in the committee.
“If internal (RBI) members are in majority, there is no need for governor to have veto power. If external powers have majority, governor should be given veto power. Otherwise, the central bank’s independence will be compromised,” the policymaker familiar with the RBI’s discussions said.
Chief Economic Adviser Arvind Subramanian declined to address the veto issue when asked by reporters: “We haven’t got to that stage yet.”