March 28: The Reserve Bank of India (RBI) stands in real danger of losing its independence and its governor could be stripped of his exclusive prerogative to frame monetary policy if the government accepts the report of Justice B.N. Srikrishna committee, which has recommended a raft of regulatory reforms in the financial sector.
The Srikrishna report, which was placed in the public domain today, seeks to severely hem in the country’s oldest regulator — the RBI — which was set up under a statute in 1935.
Until now, the RBI has operated within a sphere of relative independence but in consultation with the finance ministry, often adopting monetary measures that were completely at odds with the views of the finance ministry and other mandarins on Raisina Hill. Governor Duvvuri Subbarao, for instance, didn’t cave into the growing clamour for interest rate cuts last year and adopted a hawkish line that set him apart from other central bankers around the world.
Under the new framework, the report says the finance ministry should kick-start the process by “defining the objective of monetary policy”. It will do this by putting out a statement defining a quantitative monitorable “predominant” target. Subsidiary targets will then be tacked on “which will be pursued when there are no difficulties in meeting the predominant target”. The ministry usually holds discussions with the RBI governor before every quarterly review of monetary policy, but it has never explicitly set numerical targets for the central bank.
The role of the RBI governor will be severely circumscribed with the report suggesting that an executive monetary policy committee (MPC) will be formed to vote on policy decisions — borrowing an idea from the US Federal Reserve and the Bank of England.
“The MPC would meet regularly, and vote on the exercise of these powers, based on forecasts about the economy and the extent to which the objectives are likely to be met,” the report said.
RBI governor Duvvuri Subbarao appears to have had some inkling of the momentous change that had been suggested. On Monday, he had told reporters while on a visit to Port Louis in Mauritius that the central bank needed greater independence before it could adopt a monetary policy committee structure.
“India needs to move towards a monetary policy committee structure,” Subbarao had said. “For that to happen…. one of the necessary conditions must be more independence of the central bank.”
“The MPC would operate under conditions of high transparency, thus ensuring that the economy at large has a good sense about how the central bank responds to future events,” the report said.
In a speech at Basel in 2011, Subbarao had explained how monetary policy decisions have been taken in India. “Monetary policy decisions are made by the governor, There is no formal committee structure like the FOMC of the Fed or the MPC of the Bank of England. The governor holds structured consultations with the four deputy governors and they constitute an informal MPC... By its very nature there is no voting in this committee and the final call is that of the governor.”
This is likely to change and could even lead to a situation where the governor is outvoted. Last month, Bank of England governor Sir Mervyn King wanted to pump more money into the British economy by buying more bonds, but was outvoted by his colleagues on the MPC.
That’s not all: the RBI will no longer have complete oversight over capital flows. The report says the finance ministry will “make rules that control inbound capital flows (and their repatriation)”. The RBI will merely confine itself to framing “regulations” about out-bound capital flows (and their repatriation). It also suggested the need for a framework for imposition of controls in emergency situations.
The recommendations have already drawn flak with as many as four of the eight members of the committee filing dissent notes.
Former central banker K.K. Udeshi had serious reservations about the way capital controls regulations were going to be framed.
“Forex reserves accretion is invariably on account of a capital account surplus … there is widespread concern among several central banks in emerging market economies about the added pressures on monetary management due to the prevailing extraordinarily strong and volatile cross-border capital flows.
“If the RBI has no say in initiating policy relating to these volatile flows, it would be constrained to take monetary policy measures… to deal with the consequences of such flows; such measures may not be what the government or industry and the business community seek, leading to overall dissatisfaction,” Udeshi added.
The Commission recommended combining regulation of all investment vehicles and individuals into a single, unified framework: the qualified financial investor (QFI). “Creating a single investor class for foreign investments would considerably reduce uncertainty, compliance costs and the time taken to make investments without in any way altering the domestic investment framework,” the report said.
The RBI will also lose all say in the management of public debt. The commission trotted out the familiar “conflict of interest” argument to explain why it should be taken out of the RBI’s ambit. “The central bank that sells government bonds faces conflicting objectives. When the RBI is given the objective of obtaining low cost financing for the Government, this may give RBI a bias in favour of low interest rates which could interfere with the goal of price stability.” This is a line that Subbarao has always challenged, terming it a huge fallacy especially in the Indian context where massive government borrowings impinges on the framing of monetary policy.
The government is currently framing legislation to create an independent debt management office.
The RBI’s role will be restricted to three functions: monetary policy, regulation and supervision of banking in enforcing the proposed consumer protection law and the proposed micro-prudential law, and regulation and supervision of payment systems in enforcing these two laws.
One of the recommendations that is bound to raise the hackles of state governments is over the regulation of cooperatives. The commission said cooperatives carrying on financial services should be subject to the same prudential regulations as other entities carrying on the same activities.
It said state governments should accept the authority of parliament to legislate on matters relating to the regulation and supervision of co-operative societies carrying on financial services. The regulator may impose restrictions on cooperatives that will restrict them from offering special financial services in states whose governments do not accept the authority of parliament to legislate on the regulation of these entities.