Monetary Policy Committee: The Right Move

Monetary Policy Committee

The Right Move*

  M G Warrier

This decade has seen Reserve Bank of India(RBI) emerging as a centre  of attraction for almost all people, from Prime Minister  Narendra  Modi to the poorest citizen in PM’s constituency Vaaraanasi. Earlier common man had noted the Mahatma’s smile on the notes issued by RBI and identified the central bank with one of its core functions, namely issue of currency. Two successive outspoken governors, Duvvuri Subbarao and Raghuram Rajan, in their own ways, have demystified Reserve bank of India. Today RBI is understood in India, the way world understands it.

While Subbarao through his innovative financial inclusion initiatives took the message of RBI to every nook and corner of India, Rajan sent out a loud and clear message to the world that India’s central bank has a functional team of professionals who can handle several dimensions of central banking functions simultaneously. These two governors took pains to study the evolution of RBI originally conceived as an institution which would perform the functions similar to those the then Bank of England was handling in Britain, into an organization participating in every aspect of economic development, besides managing its core central banking functions like regulatory and supervisory roles in the financial sector together with currency management.

 Like Tatas once used to say, “There is some steel in everybody’s life”, today every citizen’s fortune is linked to policies pursued by the Reserve Bank of India.

Monetary Policy Committee

Contrary to the expectations of ordinary humans like this writer who criticized the attempt by the Financial Sector Legislative Reforms Commission (FSLRC) for writing a monologue report on dotted lines to satisfy certain vested interests, brushing aside all dissents even from within the Commission, we now find that the FSLRC report is being used as just a reference point for initiating long overdue reforms in the financial sector. The whole credit for this change of mindset in the finance ministry should go to one individual Dr Raghuram G Rajan, who appeared on the scene at the right time and like an avatar, disappeared from the scene after almost completing his mission in about three years.

At the risk of repetition, let us recall S S Tarapore’s May 2013 observations on FSLRC (quoted in January2016 issue of The Global ANALYST): “The Commission recommends the setting up of a statutory Monetary Policy Committee (MPC) to take executive decisions on monetary policy with each member having a vote and the Chairperson having a veto, which must be explained with a public statement. The devil is in the detail.

There would be only two RBI members and five external members appointed by the Government. The Ministry of Finance nominee would be a non-voting member on the MPC but would articulate the Government viewpoint. With Big Brother watching over their shoulder, brave would be the external member who would deviate from the Government line. The RBI would be better off with the present arrangement.

The leitmotif of the FSLRC is to charge the gate of the temple of money with iconoclastic fervor. One prays that in this internecine battle, RBI’s Pretorian Guards fight off the charge of the Commissioners. One must remember that countries that destroy their central banks destroy themselves.”

Tarapore retired as Deputy Governor, RBI some twenty years ago. But post-retirement, literally till his last breath, he remained a watchdog of the rights and responsibilities of the central bank which he served for more than three decades. His writings and speeches during the last two decades can easily be prescribed as a treasure of teachings on policy formulation and implementation by RBI.

It is unfortunate that Tarapore did not live to see the changes that RBI under the able leadership of Dr Rajan could bring about in the concept of MPC. In effect, while the RBI Governor is now unburdened of the individual responsibility of deciding on Monetary Policy, the central bank could get the existing arrangement of Technical Advisory Committee legalized and professionalized.

The six-member Monetary Policy Committee, constituted under the new dispensation during the last week of September 2016, has three renowned economists ( Chetan Ghate from Indian Statistical Institute, Pami Dua from Delhi School of Economics and Ravindra Dholakia from IIM- Ahmedabad) nominated by GOI, the Deputy Governor(R Gandhi) and the Executive Director(Michael Patra) in charge of the concerned department in RBI as members with RBI Governor as Chairperson. In case of a tie, Governor will have a casting vote.

There is a conscious effort on the part of government to broad-base decision making and infuse professionalism in processes, as is evident from the accommodative approach to RBI’s views on MPC and choice of government nominees  from among the best available experts in the field.
The newly constituted MPC, going by the profiles of its 6 members is a professional body of experts, each member capable of applying his/her mind while participating in deliberations. RBI is known for allowing free expression of views in In-house meetings. During the Technical Advisory Committee days, though the final call was to be taken by the Governor, he benefit of individual perceptions expressed by the TAC members had helped decision-making to a great extent. Since the time the constitution of MPC was announced, a section of analysts has been apprehensive of MPC dividing itself into Team A(RBI) and Team B (GOI) and voting for constituency interests, making casting vote by Governor essential to take decisions. This uncharitable lament brings disgrace to the professional integrity of individual members.
We need to give a fair chance to MPC to evolve itself as an expert body unburdening the RBI Governor from individual responsibility for every policy decision.

Dr. Rajan during his tenure as Governor felt that,  for all the unpalatable monetary policy decisions taken by the RBI by virtue of its position, the Government, the Finance Ministry, the Industrialists, Public Sector banks, and common man, affected by the decision were critical of RBI.  The Governor had to bear the brunt of the attack as though he had done great injustice for his personal gains. Such a perception might have worked in favour of his support for a formal committee approach to decision-making, more than the half-baked recommendations on the subject by FSLRC.

In a way, MPC formalises and professionalises the existing Technical Advisory Committee (TAC) which has been advising RBI Governor on crucial issues concerning monetary policy. To the extent that TAC’s advice was made known to the public, RBI has been trying to be transparent even where Governor differed from the TAC’s perceptions.  The present arrangement unburdens RBI Governor from individual responsibility in decisions on monetary policy and makes the MPC comprising experts more relevant.

The initial criticism that the Monetary Policy Committee  suffers  from imbalance of expertise as majority members happen to be professional economists should now fade out. While all the three GOI nominees are renowned economists, Governor, a Deputy Governor and an Executive Director from within RBI (one a career central banker and another a career economist, both with decades of relevant central banking and administrative experience) will be able to provide inputs on needs and expectations of banking sector and the economy in general.

In sum, the constitution of MPC strengthens RBI Governor's hands and sends out a clear signal that GOI is serious about retaining RBI’s status as an expert professional body. The MPC met for the first time on the eve of October 4, 2016 Monetary Policy Announcement which saw a base rate cut of 25 basis points. The decision by the MPC, reportedly, was unanimous. We need not read much into the unanimity in the MPC about the first rate cut. Such bodies have different ways of functioning, depending on the leadership provided by the Chairperson.

In this case, the harmless observation one can make, before the views of the MPC reaches public domain (after a fortnight from the date of policy announcement) is, after the deliberations, each one of the individual members would have decided to fall in line with the idea of going for a rate cut. Other than their own perceptions about the path inflation may take, the need to send out a message that the Committee will not remain satisfied with ‘status quo’ and is willing to move forward and experiment and the likely advancement of Union Budget presentation by a month would also have weighed in favour of the decision.

Inflation targeting

Having appreciated the introduction of the concept of Committee approach to decision-making, let us not ignore the changes in policy formulation and implementation it signifies. In sum, while chasing the inflation target is the responsibility of Reserve Bank of India, the central bank has lost control of the major weapon in its armory for fighting inflation. The reference here is to the transfer of responsibility to decide policy rates to MPC.

It was in this context that while negotiating under the able leadership of Dr Rajan, RBI accepted a flexible and moving inflation target ( 4 plus or minus 2 per cent with different milestones to be achieved at different points of time). Non-achievement of inflation target will have to be explained by RBI. Here what will matter is the way in which RBI articulates its views on the need to align fiscal and monetary policies to ensure optimum or ‘optimum possible’ economic growth, retaining the inflation within the targeted levels. The new RBI Governor Urjit Patel may not speak as often on these issues as his predecessor did, but is known for clarity of his perceptions.

Patel spoke much less in his maiden policy conference on October 4, but did not fail to put the records straight on RBI’s stance on inflation targeting and clearly spell out his perceptions on future course. He referred to the pursuit of self-imposed targets and framework agreement with the government which preceded the amendments to the Reserve Bank of India Act and the associated notification. He further clarified that now all those ad hoc measures are superseded by the legal amendments and the notifications on constitution of MPC and setting out the inflation target at 4 per cent by 2021 with a 2 per cent tolerance level.

There has been some criticism in the media about the change in format of the Monetary Policy Statement issued after October 4, 2016 review. Some analysts tried to read inconsistency in the mention about upside risk of inflation and rate cut, forgetting that the rate cut was in ‘ present tense’ and the possibility of upside risk was in future, to control which measures outside monetary policy, which have more to do with fiscal policy were also necessary.  

Impact of rate cuts on lending/deposit rates

While talking on rate cuts, one thing the previous RBI governor Raghuram Rajan was sadly aware all through his tenure was the slow trickling down of the impact of base rate reduction to the ultimate retail lending rates of banks, while he noticed quick action by banks in reducing deposit rates immediately following each rate cut. It is comforting to find that there is continuity of thought process in RBI on this aspect also. RBI Governor had this to say on the day of monetary Policy Announcement:

“I agree that the transmission through bank loans is less than any one of us would have liked. We are hoping that over the next quarter or two, keeping in mind that the government has also reduced small savings rate, the MCLR calculation will throw up more transmission. The transmission in new lending has been much better.”

  

This season, ICICI Bank, for instance, reduced deposit rates by 15 to 25 basis points about a month prior to the October 4, 2016 rate cut by RBI. GOI, in the name of linking small savings rates to the yield on G Sec, nowadays reduce interests on small savings scheme instruments including PPF off and on. In his observation quoted earlier, RBI governor was referring to the the latest such reduction for the October-December 2016 quarter. The reduction was by 10 basis points(100 basis points= one percentage point). Perhaps, GOI may have to introduce differential interest rates, from a pure social security angle, offering interest at a percentage point higher for savers who are solely dependent on interest income for survival.

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 *A slightly edited version of this article appears in the forthcoming issue of The Global ANALYST