Monday, August 3, 2015

An Ideal Monetary Policy Committee (MPC) for India

with Surjit Bhalla



Introduction

    As India moves towards implementation of an inflation targeting mechanism, the debate about the structure of this policy has intensified. To date, monetary policy has been the exclusive domain of the RBI, and within the RBI, under the exclusive and sole discretion of the Governor. To be sure, the RBI has a large and competent staff which feeds inputs to the governor. In addition, the Governor has a seven member Technical Advisory Committee, composed of non-RBI experts, who deliberate, and recommend, monetary policy, including Repo rates, to the RBI. However, the RBI is not bound to the TAC recommendations. In this regard, the RBI governor has complete and absolute authority on monetary policy as do his counterparts in Latin America (e.g. Brazil, Chile, Mexico), New Zealand, and Sweden (a partial listing of countries where the central bank governor has absolute authority).

Financial Sector Legislative Reforms Committee

   In March 2011, the previous UPA government appointed a nine member Financial Sector Legislative Reforms Committee (FSLRC) under the chairmanship of former Supreme Court judge, Justice Srikrishna.  The committee was to decide on various regulatory aspects of Indian financial institutions, including the RBI.  Srikrishna had just completed (June 2010) a tenure for the UPA government on the bifurcation of the state of Andhra Pradesh, which eventually did happen in 2014.

UPA Finance Ministers (PC Chidambaram, Pranab Mukherjee) consistently had problems with the RBI governors. Possibly because of these strained relationships, the FSLRC seemed to endorse the view that RBI wings needed to be clipped, and then some. In the first FSLRC report (March 2013) the proposal for monetary policy implementation was as follows:  "the creation of an MPC that would determine the policy interest rate.  In addition to the Chairperson and one executive member of the board, the MPC would have five external members. Of these five, two would be appointed by the Central Government, in consultation with the Chairperson, while the remaining three would be appointed solely by the Central Government."  However, V1.0 did allow the RBI governor to have veto power in the MPC decisions under “extreme circumstances”.

FSLRC V1.0 was a mixture of vote and veto – 2 members from RBI (Governor & Deputy Governor for economics & monetary policy, two external members selected by Governor and 3 selected by the Central Government.  All five would, however, formally be appointed by the Central government (read Ministry of Finance or MoF).  Implicitly, four of the five external members of the MPC would have to agree to a course of action different from the Governor to override him.

Expert Committee on Monetary Policy Framework

   Subsequently RBI’s Expert Committee headed by Deputy Govorner Urjit Patel’s report in Jan 2014, recommended an MPC with a difference balance. The report advocated inflation targeting along with an MPC, and the latter was to be constituted as follows: "The Governor of the RBI will be the Chairman of the MPC, the Deputy Governor in charge of monetary policy will be the Vice Chairman, and the Executive Director in charge of monetary policy will be a member.  Two other members will be external, to be decided by the Chairman and Vice Chairman on the basis of demonstrated expertise and experience in monetary economics, macroeconomics, central banking, financial markets, public finance and related areas." This Report was noteworthy for the fact that it would be near identical in power structure to the present, no MPC structure i.e. RBI in control. Even if both external members of the MPC disagreed with the Governor, he would always have at least a 3-2 majority, thus effectively ensuring a veto for the Governor (without the need for a formal veto).

FSLRC Version 2?


   On July 23rd, Government put a draft proposal for comments on its web site, which some assumed was version Version 2.0 of the FSLRC proposal, but what is apparently a modification based on comments received by the MOF on the original FCLRC recommendations.   According to this modification, the MPC which would comprise of 3 members of the RBI (instead of 2 before) and four external members nominated by the MoF – and no extreme circumstances and no veto power! This recommendation goes against almost any definition of an independent central bank.

Global Practice & Recommendation

   The table lists the practice of monetary policy in 14 selected countries. It can be seen that the FSLRC V2.0 is comparable to a few of the selected countries – e.g. Korea, Norway, Philippines. While some parts of the media have suggested that the Indian structure is similar to Thailand, that is not the case; while Thailand does have a 7 member committee, all 7 members are appointed by the Central Bank.  

Israel seems to have the best mix among the existing systems. The Governor chairs the MPC consisting of 6 members, with three outside members selected by the Central Bank. In case of a tie, the Chair has the deciding vote (not clear on Israel central Bank website). This is our first proposed structure of the MPC, based on the best in emerging market practice.

Our second proposed structure (and the one we really prefer) is that the MPC be a
formal five (or seven) member body with the Governor as Chairman and four (or six) outside professional experts as members.  The experts cannot be employees of either the RBI or the Government of India. All four (six) members must have knowledge and expertise in macroeconomics and monetary and/or fiscal policy. The government will have the right to suggest a list of names for the consideration of the RBI, but the Governor will have the right to choose and appoint those he wants, subject to the above criteria. The decisions of the MPC will however be binding on the Governor. This means that if and only if three (four) of the four (six) independent members of the MPC agree on a policy course different from that proposed by the Governor, would the Governor  be obliged to accept their decision.

Conclusion

Regardless of which of our proposed structures is adopted, we want to emphasize that it is important that RBI have both the responsibility and accountability of monetary policy. It should also be, and seen to be, independent of the government of India. Finally, accountability of the RBI would mean twice a year presentations (and grilling!) by parliamentarians, not unlike the practice in the US. The latter, of course, cannot happen if the parliament is not allowed to function!



Table: How does the rest of the world manage monetary policy?
Country
Is there a special Monetary Policy Committee?
Composition of Monetary Policy Committee
Total
Central Bank
External

External Appointments by

Central Bank
Government
External/Government Dominance







Philippines
Yes
7
1
6

0
6
Australia
No
9
2
7

0
7
Korea
Yes
7
2
5

0
5
Norway
Yes
7
2
5

0
5
India (FSLRC V1.0)
Yes
7
2
5

0
5
India (Draft Financial Code, FSLRC V2.0)
Yes
7
3
4

0
4
Chile*
No
6
5
1

0
0
Central Bank Dominance







Israel
Yes
6
3
3

3
0
Thailand
Yes
7
3
4

4
0
UK
Yes
9
5
4

0
4
India (Urjit Patel Committee)
Yes
5
3
2

2
0
Sweden
Yes
6
1
5

5
0
Complete Central Bank Control







Canada
No
6
6




Indonesia
No
6-9
6-9




New Zealand
No
1
1




South Africa
Yes
8
8




India (present)
No
1
1




Source: Central Bank websites







*Veto power exists for the Finance Minister, unless all 5 Central Bank Board members unanimously agree on a decision

 --------------------------
A version of this article was published on July 29, 2015 in the Indian Express and the Financial Express (http://indianexpress.com/article/opinion/columns/an-ideal-mpc-for-india/ and http://www.financialexpress.com/article/economy/an-ideal-mpc-for-india/109713/ respectively)

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