S S Tarapore

Legislation on RBI autonomy

S. S. Tarapore | Updated on April 12, 2011

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Central bank policies have to be broadly consistent with overall economic policy objectives, but the central bank does need an element of operational autonomy.

The Financial Sector Legislative Reforms Commission (FSLRC) held its first meeting on April 5, 2011.The terms of reference of the Commission are wide and, although the term is two years, the task of the Commission is daunting.

There are various aspects of autonomy. Some central banks derive their autonomy from traditions while others have legislative autonomy but do not have operational autonomy, and there are yet others that have neither legislative backing for autonomy nor operational autonomy by way of tradition. The Reserve Bank of India (RBI) belongs to this latter group. Central bank policies have to be broadly consistent with overall economic policy objectives, but within the overall framework, the central bank does need an element of operational autonomy.

The present RBI Act is archaic and forecloses the effective discharge of responsibilities. There are many lacunae in the RBI Act but a few key drawbacks are set out below. While the government should have the right to appoint the Governor, the procedure should be akin to the appointment of the Comptroller and Auditor General of India, which is a Constitutional appointment. The Governor should have a single, non-renewable tenure of seven years. Such a long tenure is desirable as it would not be co-terminus with the electoral cycle.

It would ensure that political economy considerations do not determine the appointment and tenure of the Governor. In the past two decades, the term of the Governor has been two or three years and extended by a year or two. The earlier tradition was a full five-year term (in the recent period there was one notable exception where the appointment has been a full five-year term).

Appointment, remuneration

Although the Governor is not directly accountable to Parliament, increasingly, Governors are expected to appear before Parliamentary Committees. It would be best if there were a formal periodic deposition by the Governor before a Parliamentary Committee.

Dismissal of a Governor should be only through a well-set-out procedure of Parliamentary impeachment, which should be strictly limited to personal malfeasance, bankruptcy or lunacy.

The RBI Board members should be appointed by the Board itself, with one-third of the members retiring every four years and no member should have a total tenure of more than eight years. The appointment of Deputy Governors should be made by the RBI Board and there should be a single, non-renewable tenure of five years. This would avoid political patronage.

Again, remuneration of the RBI officials should be determined by the RBI Board. The present impasse on the remuneration of RBI officials, being determined neither by the Pay Commission for government employees nor public sector units, is totally untenable. The RBI should not be treated like a poor relative of the system. There should be a requirement under the legislative framework that there should be an Agreement between the Government and the RBI as to the specific objectives of medium-term monetary policy with a clear prioritisation of objectives. This Agreement should be put in the public domain and any amendments should also be placed in the public domain, explaining the rationale for the changes. Once the objectives are set out, the RBI should have instrument independence on how to attain the objectives.

There should be a provision in the RBI Act enabling the RBI to set up a Monetary Policy Committee (MPC). A large number of central banks have such a Committee as a legislative requirement. The MPC should be empowered to take decisions on key aspects of monetary policy.

The MPC should consist of the Governor, the four Deputy Governors and four external experts, each with a four-year term. One fourth of the external experts should retire each year.

The external experts should be remunerated as part-time top management officials. Decisions of the MPC should be by majority vote and the full minutes of the MPC should be put in the public domain after a stipulated period of time.

The present Technical Advisory Committee on Monetary Policy is a poor substitute for a MPC with legislative backing and clear responsibilities and accountability. The Report of the RBI Advisory Group on Transparency of Monetary and other Financial Policies (2000) should be revisited by the FSLRC.

Similarly, the RBI Board should be empowered by legislation to set up a Board of Supervision consisting of independent experts who should be remunerated as part-time top management.

Violations, penalties

At present, penalties for violations of the regulatory framework are stultifying and are not effective deterrents. The penalties should involve a strong deterrent, such as twice the undue enrichment.

The present system of handling financial frauds is permissive and there should be legislative requirements that these cases have to be brought to their logical end within a stipulated period.

The Commission should arrange to have a comprehensive comparative study of central bank legislation in a large number of countries which would facilitate its work.

There are many other areas where the RBI legislative framework needs to be revamped. The FSLRC has a long journey ahead, indeed!

(The author is an economist. >blfeedback@thehindu.co.in)

Published on April 08, 2011

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