1. Narendra Modi govt, RBI heading for potential clash over who decides rates

Narendra Modi govt, RBI heading for potential clash over who decides rates

Raghuram Rajan triumphed this week by binding PM Narendra Modi's 10-month-old govt to a monetary strategy built around inflation targeting.

By: | Mumbai | Updated: March 17, 2015 10:43 AM
Raghuram Rajan, RBI, RBI rate

RBI Governor Raghuram Rajan triumphed this week by binding PM Narendra Modi’s 10-month-old govt to a monetary strategy built around inflation targeting. (reuters)

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.

RBI, RBI rate cut, RBI interest rate cut, SLR, SLR rate

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. (PTI)

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.


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.”


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  1. A
    Alok Asthana
    Mar 7, 2015 at 2:20 pm
    BJP means Ambani, Adani. We just can,t take that risk. Supreme court, please save India.
    1. C
      Mar 7, 2015 at 1:17 pm
      The atude of the RBI Governor has been on a conflict path with the Govt. since the beginning. It was too obvious. His comments & criticisms of the Govt. Policies (such as make in India) exceeded his brief. If He does not change his approach, should be shown the door. May be he feels more loyal to those who appointed him than to the present dispensation.
      1. C
        Mar 7, 2015 at 8:49 pm
        The manner in which the rate reduction was made, much earlier than it was due for review, shows that the governor has sucbed to the pressure from the govt. If the Governor had reduced the policy rate by 50 basis points in January one would have thought it to be an independent decision. But having decided to restrict then to 25 points, one wonders what additional strengthening of the economy has taken place during the past three weeks! The major reason for lower inflation has been the fall in the price of oil. Since mid Jan, the crude price has hardened and consequently the price of petrol and diesel has been increased by Rs 3 per litre. Therefore, the inflation was bound to rise. The reduction in subsidies was the result of the fall in the oil price and not due to a change in budgetary policies. That some of the subsidies would be dispensed through direct transfer was not a new revelation after the budget. A beginning was already made before the Jan policy rate revision. One therefore cannot help but feel that the present rate revision of 25 basis points, was ill timed and not warranted by a change to the outlook on inflation since the Jan revision. The banks had not revised the interest rates since the policy rate change by the RBI in Jan. So where was the need for a further revision hoping that there would be a reduction in the interest rates by the bank? A reduction in the interest rate by 25 points cannot make any difference to the demand; the only beneficiaries were the speculators in the stock market. In announcing an untimely rate cut, without even referring to the outside consultants as this report suggests, the Governor has sacrificed the independence of the central bank in deciding the monitory policies and fallen from the high pedestal he was perched earlier.
        1. S
          Mar 7, 2015 at 3:01 pm
          if RBI gov cannot respect the peoples mandate , then he should quit and let the peoples mandate prevail.
          1. Sridhara Hiriyannaiah
            Mar 7, 2015 at 12:25 pm
            This congress stooge needs to be changed soon.
            1. I
              I Majumder
              Mar 7, 2015 at 1:31 pm
              A very critical move that would decide the future of the monetary policy . Sine inflation targeting is accepted as a biding factor by both the sides ( Gov & RBI ) , it is important to have an other than RBI body for the the Monetary Policy . Otherwise Growth/Industry would suffer due over inflation focus as done by the RBI presently . CPI is weighted mostly on food prices on which Monetary policy has little control yet tight monetary policy of RBI has has blocked Growth . Committee approach is therefore welcome . 5 wit the veto of the Gov RBI is better as it has the desired sharpness and protection
              1. Paddy Singh
                Mar 7, 2015 at 2:29 pm
                If the Reserve Bank Governor, in this case Rajan, cannot be left and trusted to decide interest rates, let's pack up the insution and let the corporate cronies of the government take over. Modi will eventually make a fool of himself because his so called friends have no loyalties, only interests.
                1. G
                  Gautam Sen
                  Mar 8, 2015 at 9:56 am
                  No single approach to fiscal or monitory decision making is desirable. Rajan is clearly a captivev of his IMF psychology while any Indian government is a captive of populist politics as they have seen what the results can be if pragmatic populist policies are followed. Rajan will most probably be eased out before long as India's representative in an international organization or bank not necessarily in IMF or the WB. Rajan knows that well. So he is keeping the present government in good humor lest he lands up post Governor RBI in some indiscrept think tank consigned to lecture on behalf of some economic think tank. Subramanyam is no fan of Rajan and there rests the case in terms of his replacement. Rajan has a tight rope to dance on if he wishes to finish his term as RBI Governor
                  1. B
                    Mar 8, 2015 at 9:26 am
                    I feel this Rajan seems to put hurdles to Modiji government. He should sail with PM for all the decisions. Recent interest rate issue should have been discussed with PM. This rajan is not holding the highest post of the country. He should respect PM. I feel this fellow- seems to be arrogant - has to be sacked before he makes more problems to Modiji government.
                    1. Satya Narayana
                      Mar 7, 2015 at 6:32 pm
                      Raghuram Rajan is a Congress loyal person . After change of Govt. new govt. lead by Modi should have appointed person loyal to his govt. & respecting his views on monetary policies rather creating rift and thereby supporting his former mentors of Congress to breath happy and frustrating Modi. Modesty not to change previous govt. appointed beurocrates paying heavily on present govt in my opinion.
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