Is North Block pruning RBI’s powers?

Is North Block pruning RBI’s powers?

FPJ BureauUpdated: Friday, May 31, 2019, 11:41 PM IST
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The RBI’s powers to conduct monetary policy will be severely curtailed if the recommendations of the revised draft of the Indian Financial Code (IFC) prepared by the Financial Sector Legislative Reforms Commission are accepted by the NDA government. They include removing control over interest rates from the central bank among others and have triggered sharp criticism from former RBI governors and economists. The finance ministry has been quick to turn tail with Jayant Sinha, minister of state for finance, stating that IFC’s suggestions are only an input into policy-making deliberations and do not represent the government’s thinking!

Deep down, North Block desires to clip RBI’s powers, especially of its high profile governor Raghuram Rajan who prefers to control inflation by keeping rates steady. North Block instead, prefers that RBI cut rates more aggressively to kick-start economic growth. But for the record, Mr Sinha issues pro forma statements supportive of the central bank’s autonomy: “The cardinal principle we want to follow is that we have a genuinely independent central bank that is able to fashion monetary policy in a truly independent and objective manner.”

As the RBI has so far only partly obliged the government on the interest rate front, the latter evidently wants to take charge by securing control over interest rates. Are policy rates holding back the world’s fastest growing economy? Expressing the point of contention between the central bank and government as inflation versus growth trivialises monetary policy, whose objective is price stability, while keeping in mind the objective of growth. Similarly, the choice before economic policy is not growth versus distribution but growth with distribution. Which RBI governor has sacrificed growth for price stability?

There are no prizes for guessing that the IFC plays into the hands of the finance ministry. In an ideal scenario, the elected representatives of the Parliament should have a say in setting a desirable inflation target – for example, a 4 per cent rate of consumer price inflation in 2016 -17 – and the RBI through a Monetary Policy Committee should be given the mandate to deliver it. Not so, states the revised draft: The RBI will be bound by the decisions of a seven-member MPC, in which the central government with four members has the blocking majority, to determine interest rates. But the RBI will be held responsible for achieving the inflation target!

The IFC’s recommendations clearly erode RBI’s independence. Unfortunately, all of this is happening when the central bank has moved towards inflation targeting and has signed a monetary policy framework agreement with the finance ministry in February 2015. The target has been specified as achieving 6 per cent inflation by January 2016 and 4 per cent in subsequent years. RBI will establish an operating monetary procedure to attain this target. It is clearly stated that the RBI governor or his deputy, in his absence, will determine the rate as well as any other monetary measure to attain the inflation target.

If this monetary policy framework hasn’t broken down, what is the warrant of fixing it? The IFC goes on to suggest that inflation targets be set every three years. If the inflation target is not met, the Reserve Bank must set out in a report, the reasons for it not being met; remedial actions proposed to be taken; and the time-period within which the inflation target is proposed to be achieved pursuant to timely implementation of proposed remedial actions! RBI’s governor responded that medium-term targets for inflation must be internalised by everybody. Changing them every three years means changing the target as soon as people internalise it.

Why does RBI focus on controlling inflation and keep rates relatively steady when growth deserves greater priority? Evidently, the governor appears to be more worried about the upside risks for inflation than downside risks for growth. Even with the expected edging down of consumer inflation to 5.4 per cent in June 2015, there might be possible upside risks to hitting the targeted 6 per cent by January 2016. Even if the southwest monsoon is unlikely to be deficient, contrary to the prediction of the IMD, inflationary expectations have perhaps already set in to affect consumer prices, especially of food items like onions and pulses.

For all this focus on targeting consumer inflation, the big question is whether monetary policy really helps in dealing with food and vegetable price inflation? Interest rates have less of a role to play as this phenomenon is more on account of demand-supply mismatches and supply-side shocks arising from localised agrarian distress conditions. For various reasons, food inflation has stubbornly persisted in the system. For instance, why are prices of essentials spiking up despite indications that this year’s ‘kharif’ or summer crop might not be adversely affected as sowing operations have taken place on time? Speculation and hoarding can upset the inflation target.

Keeping interest rates up—even if their impact on food inflation is somewhat exaggerated—perhaps has a rationale beyond targeting retail inflation. This pertains to the current state of global environment in which the most powerful economy in the world, the US, is set to raise interest rates. The question is not if but only when. The US economy is now fast emerging as the growth engine of the world economy and the latest numbers indicate a further drop in unemployment rates, all of which may prompt the US Federal Reserve to raise interest rates.

RBI would loathe being more accommodative just when the rates firm up in the US, which will lead to a surge of foreign portfolio investments out of the economy. The rupee will take a huge hit in the process. Monetary policy cannot simultaneously control inflation, stimulate growth and simultaneously defend the exchange rate of the rupee. At best, only two of these objectives can be satisfied. The IFC has nothing to add on these matters besides stating the objective of monetary policy is to achieve price stability while striking a balance with the objective of the government to achieve growth.

(The writer is an Economics and Business Commentator based in New Delhi)

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