The Ministry of Finance (MoF) and the Reserve Bank of India (RBI) have reportedly come to an agreement over the proposed monetary policy committee (MPC). According to reports, both sides will have equal representation, with the RBI Governor having the deciding vote on interest rates. The newly proposed MPC is likely to have a six-member panel— with three members being nominated by the government and an equal number coming from RBI. The newly proposed MPC, with the RBI governor having the deciding vote on interest rates, is set to be endorsed by the Union Cabinet. The decision comes after a turf war over the constitution of the MPC that will replace the existing system, where the RBI is the sole authority on interest rates, although the Governor does consult a technical committee. In this turf war, it does seem as if the RBI Governor has marched ahead. Earlier this year, in a move to dismantle the RBI Governor’s powers, the Centre had 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), 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 MoF. 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 MoF’s revised draft of the Indian Financial Code had clearly sought 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, it is clear that if the government-controlled MPC pushes for a rate cut, even though the RBI may not be fully convinced of its implications for 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.
On the other side of the debate, however, it is fair to suggest that most media outlets have been heavily in favour of Raghuram Rajan, whose expertise in monetary policy management is widely respected. The underlying rationale for their stand is that since four of the seven members of the MPC will be appointed by the government, the central bank will lose its independence. However, in its current form, the RBI does lack any sort of statutory independence. 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, certain experts have argued that 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 strength of character? 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 four government-appointed members will be the lackeys of the government is clearly false. Ironically, the current RBI Governor Raghuram Rajan is someone who was appointed by the government.