New monetary policy framework to give more autonomy to RBI

With the government and the central bank agreeing over a new monetary policy framework with the primary objective of containing inflation, and making the latter accountable for it, this will give more autonomy to the central bank, policy makers said. 

According to the new framework which comes with immediate effect, target for retail inflation which is the nominal anchor, is set at 6% by January 2016. The target for 2016-17 and all the subsequent years will be 4% with bank of +/- 2%.

“I have always held a view that price stability is the dominant objective of the monetary policy. The  framework reiterates that. Of course, controlling inflation requires cooperation from many areas. Nevertheless, monetary authority has a major role to play,” said C Rangarajan, former chairman of Prime Minister’s Economic Advisory Council who also served as the central bank governor from 1992 to 1997.

“The agreement between the RBI and the finance ministry clearly says that once inflation reaches beyond comfort zone, both at high and low levels, RBI should use whatever in its command to bring it to comfort zone. That way it gives autonomy to RBI,” Rangarajan added.

The new monetary policy framework is formed following the recommendation of a committee headed by RBI deputy governor Urjit Patel. Apart from inflation targeting as its prime objective, the committee suggested formation of a 5 member monetary policy committee, headed by the governor of Reserve Bank. Out of the 5 members, three were suggested to be internal from RBI (the deputy governor and the executive director in-charge of monetary policy).

“We are yet to see formulation of Monetary Policy Committee. The world over it is recognised that there should be consultation between the finance ministry and the central bank, but the central bank should have an autonomy on the monetary policy, though it may consult outside experts,” said a former central banker who wished not to be named.  The RBI Act needs to be amended to set up the committee.

“It (Monetary Policy Framework) establishes an inflation target. That is a good thing. Oddly enough there is no Monetary Policy Committee. The interest rate is decided by one person: the RBI governor. This will lead to many infirmities. But this is progress, for the period until IFC (Indian Financial Code) is enacted,” said Ajay Shah, professor, National Institute of Public Finance & Policy, and a member of Financial Legislative Reforms Commission (FSLRC).

Finance Minister Arun Jaitley said in his budget speech last week that the government will move to amend the RBI Act this year, to provide for a Monetary Policy Committee.

Before amending the act, there needs to be agreement between the government and the central bank about the composition of the MPC.

The previous UPA government was not comfortable with the idea of MPC having majority of the members from RBI on the ground that it will not take an independent view. There were also proposals to increase the number of members.

Another issue of contention was the Patel committee suggestion that the two external members will be selected by MPC chairman – who is the governor of RBI and vice chairman who is the deputy governor. There was a view, since the government appoints RBI governor and deputy governor, it should also appoint the members of the MPC.

This theory was however challenged on the ground that if government appoints committee members which could be bureaucrats, then the members will take the government view.

Experts have suggested that members of MPC should be professionals and not a part of government. “It is still not clear whether there is a meeting of minds between the government and RBI on how the MPC will be constituted. This entire process may take at least six months to get completed,” said A Prasanna, chief economist, ICICI Securities Primary Dealership.

He said the amendment could be introduced in the next session of Parliament, if it gets passed in both houses, even then conservatively it would take about 6 months.

“India has paid a big price in the past for not having clarity on monetary policy objectives. This is a step in the right direction. Now that the government has given RBI a target for inflation and there will be a committee to take decisions, ideally all stakeholders should believe that the committee will objectively do its job. As such there should be less external pressure on RBI to pursue a particular course of policy,” Prasanna added.