The Reserve Bank of India will survive any Governor and it is important not to “personalise this office”, the outgoing Raghuram Rajan said days before his surprise announcement that he will not continue in the job. “What is important is to not personalise this office. It will survive any Governor, it is bigger than any Governor,” the Economist magazine quoted Rajan as saying in its latest edition. In other words, the institution is always greater than any individual. On the subject of the institution, today's column will focus on the RBI's future role in determining interest rates. The next monetary policy review will be in August, by which time the RBI will set up its new monetary policy committee (MPC), an institution proposed by the government and backed by the current RBI Governor.
The MPC’s sole task will be to decide the rates at which the central banks lend. In other words, target inflation. Until this year, the rate was decided solely by the governor in consultation with a technical advisory panel within the RBI. The new MPC will include three members from the RBI—the governor, deputy governor and another central bank nominee—as well as three members nominated by the government. It is imperative to note here that the RBI governor will only have a casting vote in the event of a tie. As per the RBI Act of 1934, all 21 members of the central board of directors, including the governor himself, are appointed by the Government of India. One interpretation of the existing law clearly stipulates that the government can dictate policy to the central bank, which the RBI Governor will be obliged to follow.
Therefore, any apparent independence that the RBI may enjoy is clearly dependent on how its Governor responds to political pressure. Under Rajan, the RBI has admittedly shown a great deal of independence from political and corporate pressures. However, such a model, where the RBI governor is the sole arbitrator of a nation’s monetary policy, will not leave the institution in good health. What if the next governor does not possess Rajan’s courage of conviction? As the sole arbitrator of monetary policy, such a governor will constantly be under pressure to toe the government’s line at the expense of public interest. The assumption that all three government-appointed members will be the lackeys of the government is a little misguided. For example, the Comptroller and Auditor General of India is a government appointee. Under the revised MPC, the RBI Governor will have to at least consult a committee before a final decision is taken on lending rates.