Coincidentally, the announcement by Reserve Bank of India (RBI) GovernorRaghuram Rajan to move on after his term comes to an end corresponds with a new era for monetary policy formulation. The ministry of finance has now formally announced the constitution of a search committee to appoint three members to the new Monetary Policy Committee (MPC). The other three members will be from RBI, including the Governor, deputy governor and one with a rank of non-deputy governor.
This could, prima facie, also mean substantial dilution of monetary policy power of RBI, as all decisions taken will be joint ones by the committee members. Another interesting part of this new approach is that the MPC will have to meet at least four times a year, which means that a meeting before every policy is not mandatory and only optional.
The next policy will witness, for the first time, a committee-based decision, and while the RBI Governor will be the chairperson and would probably make the speech, the decision, after 82 years, would be in the hands of a committee which will make it special. When RBI has been publishing the minutes of the technical committee after each meeting, we do often hear of a difference of opinion between the members and the Governor, with the latter, however, enjoying the clinching vote. Henceforth, the view will be of the majority, though a tie will give the Governor a casting vote.
Two interesting points come up here. The first is that RBI is to target inflation within the pre-decided band, and in case it fails to do so for three successive quarters, it would be held responsible for the same. Now, it is not clear what would be the punitive action in case prices continue to be either higher or lower than the band. This has not been spelt out. In addition, the band which was anchored earlier at 4% with 2% band either way has not historically been easy to achieve, with CPI inflation being above 5% in nine of the last 10 years.
Now, RBI has only one tool for controlling inflation, which is the interest rate; it can keep lowering or increasing the repo rate to be within the inflation band. It will be interesting to see how the committee decides on this rate. Will it be that if inflation keeps moving downwards of, say, 6%, the repo rate will be dropped commensurately? Alternatively, would the repo rate be increased in case inflation, for some reason, increases or is expected to increase, but be within the band? And, more importantly, what would the MPC do if the prices of pulses keep rising continuously even when rates are increased?
The other conundrum is that, theoretically, we have seen that the CPI inflation number, which is being targeted by RBI, has been driven by food prices, over which policy has no control. Prices of tomatoes today are not going up because of low interest rates, but because of shortfall in supplies. This has been the case for most episodes of inflation in the last five years. In that case, increasing rates will not bring down inflation, but the committee will have to take responsibility for actions which, prima facie, have little relevance to the goal being targeted. This can be a concern for the MPC.
At another level, one also gets a sense that the role of RBI is gradually drifting from being the ‘monetary authority’ to the ‘instrument’ to conduct the same. Hitherto, it was the prerogative of RBI to decide on policy rates, with the assumption being that the central bank had the exclusive expertise in this domain. The new approach will bring in the wisdom of experts outside the system who may not always think like central bankers and could have views tilted to a different ideology. Having economists, academicians, corporate professionals, etc, on the MPC, while bringing in varied views, could also lead to challenges in reconciling the same.
This leads to the broader question of what will the role of RBI look like in the new scheme of things? Conventional textbooks talk about the conduct of monetary policy being the main objective of the central bank, which will get diluted. One will also recollect that RBI has moved away from the selection of directors and CMDs of public sector banks, with the Banks Board Bureau being constituted. Therefore, it does look like that RBI would tend to get more specialised in the course of time.
Further, RBI had technically moved away from supporting government borrowing directly and hence the role of banker to the government is officially only peripheral. In fact, there is also talk of moving the public debt part of the central bank into a different organisation, which probably is only some time away. Such a development would transfer yet another function of RBI.
The current thought process can lead to a situation where the public debt organisation handles G-Secs issuances, while interest rates are decided by the MPC, and RBI has the task of managing liquidity. Also, one can see the RBI role shifting more towards banking regulation and supervision, and assimilating global doctrines as laid out by Basel III to keep the system in order. Formulating policies, developing new structures and growing various markets would be the prime function of the central bank in this situation.
The question of the role of central banks has always been on the table and there are no clear answers as there are several models prevalent across the world. There is a school of thought which espouses that there should be separate roles for monetary policy formulation and banking supervision. It is generally posited that the central bank should take on the role of the former, while a special body looks after the latter. However, the current dispensation turns the tables around and would be giving RBI more the role of the supervisor which also manages other aspects of a central bank as it exists today.
Decentralisation of the functions of central banks does appear to be the flavour of the season. The four verticals of deputy governors in RBI will undergo a change if all the ideas of reallocating functions go to other bodies/organisations. While the new dispensation may not necessarily be different from the current state of operations, the conventional banker or economist could find oneself lost on the Mint Street.
No comments:
Post a Comment