Covert move to clip RBI wings?
In a move to dismantle the RBI Governor’s powers to navigate the course of interest rates in the banking system, the Centre has proposed to take away his authority to veto the interest rate decision of the central bank’s monetary policy committee. In its revised draft of the Indian Financial Code (IFC), released on Thursday, the Centre also proposed that the all-powerful committee would have four representatives of the government and only three from the central bank, including the ‘RBI Chairperson’, a move that would effectively transfer the RBI’s present interest rate-determining powers to the Finance Ministry. Rajan has consistently pursued a fiercely independent policy stance, resisting tremendous pressure from powerful vested corporate interests and their backers in the Government to reduce interest rates.
The IFC, which is conceived as an overarching legislation for the financial sector, proposes a monetary policy committee which will be entrusted with the task of deciding the key policy rate and chasing the annual retail inflation target to be decided by the Government in consultation with RBI. Further, it said that the RBI “must form a Monetary Policy Committee (MPC) to decide by majority vote on the Policy Rate needed to achieve the inflation target”. At present, the RBI Governor consults a Technical Advisory Committee but does not necessarily go by the majority opinion.
This move follows the Finance Ministry’s attempts to cut the central bank down to size earlier this year by proposing the idea to shift the power of debt management from the institution. The creation of a debt management authority will, according to experts, result in eliminating the RBI’s role of managing cash and borrowings of the government. Certain financial experts had also said that this will remove the conflict of interest, which is created because of RBI’s triple roles: investment banker to the Government of India, banking regulator and that of a monetary policy manager. Rajan, however, contended that having an independent public debt management agency does not eliminate the issue of conflicts of interest entirely.
This is because the government still has a stake in Public Sector Entities, Public Sector Banks and Life Insurance Corporation of India. He warned that such an agency should not be powerful enough to force public debt onto any of these entities. He also said that “an entity, which is purely professional, not a huge bureaucracy but which manages and designs the placement of Government debt” is ideally desirable. The Centre soon developed cold feet on this proposal.
The Finance Ministry’s revised draft of the Indian Financial Code, however, seeks to undermine the financial independence of the central bank—an institution that has constantly shielded the economy from volatility in global markets. Through this draft report, the Finance Ministry is trying to shift the onus of determining monetary policy from an autonomous central bank to a government, which may manipulate it to suit its political agenda— greater cash flow for investments at the risk of higher inflation.
The conflict of interest arising from such a scenario is clear. If the government-controlled MPC pushes for a rate cut, even though the RBI may not be fully convinced of its implications on inflation, the central bank will be forced to fall in line. The implications of such a scenario on the economy will be serious to say the very least. In the past, the Centre, under both the current NDA and previous UPA dispensation, and the central bank have been at loggerheads over the desired monetary policy outcome. As an impeccable institution, with a proven track record, the RBI has formulated the nation’s monetary policy, keeping in the mind the long-term implications its decision will have on the economy, regardless of the government’s whims and fancies. In relegating such an institution, the government has put itself on a <g data-gr-id="38">one way</g> track to financial mismanagement.