Balance is needed in selecting members for the proposed monetary policy committee, says Abheek Barua.
The new draft Indian Financial Code (IFC), specifically its proposed structure for the apex monetary policy committee (MPC) of the Reserve Bank of India (RBI), is being viewed as an attempt by the government to strip the RBI of its powers and compromise the independence of the central bank.
It might be helpful to go beyond the simple narrative of an overbearing government trying to plant its flag in a domain that has over the last few years belonged to the monetary authority, and (without taking sides) look at the various issues involved in this contentious debate.
To start with, I believe it is sensible to listen to the finance ministry's claim that it is merely a draft proposal that has been released for discussion and comments.
Thus the "extreme" stand that the IFC has taken could just be a bit of strategic positioning in the negotiation between the government and the central bank and the resolution is likely to lie somewhere in the middle.
What are the "problems" with the draft? Much is being made of the fact that the new draft proposes to strip the governor of his veto power in the final decision of the committee.
This, prima facie, need not constitute a dilution of the central bank's independence. Major central banks like the Bank of England and the US Federal Reserve Board do not have a veto for the head of the central bank and decisions are made on the basis of voting.
In fact, some would argue that veto power of the committee head could go against the spirit of a committee structure for decision-making.
We must remember that a "shadow" monetary policy committee, the Technical Advisory Committee (TAC), has been in place for a while. Reports of the TAC's meetings show that their majority advice has been vetoed a number of times.
This has made it toothless and the TAC deliberations a mere academic exercise. A majority voting structure will put the onus on the RBI governor to build consensus and convince the committee to cast their vote that carries in his favour.
One might add that for decades the chairman of the United States Federal Reserve has done this successfully.
But then again the Fed chair has many public forums to champion her case - the Congressional Hearings for instance. Perhaps some formal institutional arrangements are warranted for the RBI governor to "speak to the public", outside of the policy statement, if indeed he does not get a veto right.
The real problem seems to lie with the composition of the committee. Contrary to the recommendations of the Urjit Patel Committee report, of a five-member committee with three RBI officials including the governor and two external members appointed by the RBI, the draft code proposes a seven-member panel of which four are government nominees.
This is a clear departure from international norms, where central banks have far greater autonomy in selecting committee members. In the extreme case of an "us versus them" situation where the government nominees are all present and vote en bloc against the RBI, they will always get the upper hand.
Thus the selection of members clearly hurts the RBI's autonomy and a more balanced composition is desirable.
In all this the most relevant question is: what could a structure with some government nominees do to inflation management? It would be unfair to believe that the government will nominate faceless drones who will only do its bidding.
The government also has its credibility to protect, and the committee members are likely to be economists or other experts of stature. It is also a little far-fetched to assume that the RBI is the sole repository of knowledge when it comes to monetary matters.
Besides, there is an explicit target for inflation that has to be met. Thus it is not necessary that this structure will dilute the "inflation fighter" image of the central bank. If the RBI governor were to make a strong case for his stand on inflation, I see no reason why it will not get carried through.
Besides, it might be incorrect to assume that the government is entirely fixated on growth and blind to inflation. High inflation is politically far more damaging and visible than the fuzzy thing called growth, and any politician worth his salt knows that he can only ignore it at his own peril.
However, I do see one potential problem. This has to do with two distinct views on inflation control that have emerged in the country.
The RBI appears to go more by changes in inflation expectations rather than actual inflation prints since it appears to think expectations impact on future inflation levels. It is unwilling to dismiss supply shocks as temporary price spikes, and fears that if such shocks linger for too long it will morph into generalised inflation.
It does not entirely seem convinced that slow growth brings about adequate disinflationary pressures - and, in fact, points out that even with actual growth falling short of potential, inflation expectations can rise. Thus it is unwilling to relax its vigil on inflation.
The alternative view - one might crudely christen it the Delhi view - is that inflation appears to have come under control and will ultimately bring expectations of future inflation.
It also believes that some heed needs to be paid to the wholesale price inflation that suggests a decimation of pricing power and industrial growth. It draws attention to the global deflationary cycle that mitigates the risk of imported inflation.
Given the current balance of growth and inflation, this view suggests that a few more rate cuts will help growth without stoking inflation.
Some would see an inherent risk in the fact that the government nominees might 'over-represent' the Delhi view.
Thus the monetary policy committee might appear as a fractious and divided house. Were the RBI to choose its members, it would certainly allow for some dissent, but there would certainly be more homogeneity in the way inflation is tackled.
The ultimate question is: what degree of homogeneity is desirable? Allowing more debate and disagreement on monetary policy might actually help in a situation where no one seems to have a clear solution to the growth-inflation conundrum.
However, a monetary policy committee that speaks in Babel of tongues is undesirable. It is important to keep this balance in mind in structuring the new MPC and selecting its members.
Abheek Barua is chief economist, HDFC Bank. The views are his own.
