Freedom for the RBI

Discussions till now on the Financial Sector Legislative Reforms Commission’s (FSLRC) report submitted recently have centred around its recommendation for a unified financial regulator for the equity, bond, currency, commodity derivatives, insurance, and pension markets. But no less far-reaching, are its recommendations concerning the autonomous functioning of the Reserve Bank of India (RBI). The report has said that the central bank’s monetary policy goals should be set by the Government, which shall specify them in terms of quantifiable numerical targets. These may well accord precedence to growth over inflation, should it deem the former as presently more relevant. Moreover, even determination of policy rates would be left to a ‘monetary policy committee’, comprising two members from the RBI and five Government-appointed independent experts. All monetary policy decisions would be based on voting by the seven members, with the RBI Governor having the power to override the majority view only in “exceptional circumstances”. Even then, he/she will have to issue a “rationale statement”, explaining the reasons for disagreement.

One way to look at these recommendations — apart from the one on entrusting public debt management and bond auctions, now handled by the RBI, to a separate agency — is that they undermine the idea of an independent central bank. In the context of the recent not-so-veiled differences between the Finance Ministry (which constituted the FSLRC) and the RBI over the issue of rate cuts, it is even quite natural to voice such suspicions. But that amounts to a very mechanical reading and naïve understanding of central bank autonomy. In any democracy, policy priorities are decided mainly by the elected government representing the will of the people. The central bank can enjoy only ‘ instrument ’ independence here, pertaining to the choice of the specific set of tools for giving effect to goals that are defined by the Government.

So long as these policy objectives are clearly spelt out in the form of measurable targets set out every two years — as suggested by the FSLRC — the central bank will have enough flexibility for pursuing a reasonably stable monetary policy strategy. The establishment of an executive committee to determine interest rates and other monetary policy actions through majority vote is also not a bad idea per se , provided each member puts on record the rationale for his/her voting decisions. Since monetary policy actions ultimately affect people, and also cannot be compared with decision-making involving sensitive national security matters, there’s no reason not to subject these to greater transparency and accountability. The FSLRC’s proposed institutional mechanism to enforce such standards is certainly superior to the current arrangement, where the RBI in reality does not enjoy the policy-making autonomy that the Constitution guarantees to the Election Commission or even the Comptroller and Auditor General of India. That being so, it is better to have a rule-based system clearly specifying the RBI’s role in conduct of monetary policy than entertain naive beliefs about its autonomy.

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