Government, Reserve Bank of India face-off likely on rates

Monetary policy committees have become the norm among major central banks in the world, but how one would work in India is still uncertain, as officials have only held preliminary discussions of proposals.

The government will need to pass through Parliament an amendment to the RBI Act to clear any changes to the central bank’s objectives, officials said. Any signs of government influence in the central bank’s decisions would worry investors, given India’s history of high spending, which, if accompanied by low interest rates, could lead to a surge in inflation and deepening debt problems.

“A government’s active role in monetary policy-making risks undermining the central bank’s independence and might result in conflict of interests in terms of broader economic priorities,” said Radhika Rao, an economist at DBS in Singapore. Investors recognise the merits of reducing the influence of a single individual, even one as trusted as Rajan, and would welcome change at an institution regarded as conservative and hierarchical.

But they wouldn’t want to see India’s central bank coming under the kind of political pressure suspected of taking place in South Korea and Indonesia, for example, or suffering a controversy like one presently gripping Turkey. Although the RBI is not statutorily independent, as the governor is appointed by the government, it currently enjoys broad autonomy in setting rates. Things could be different once an MPC is established.

A panel appointed by the central bank has proposed a five-member committee, composed of the RBI governor, the deputy governor, a central bank executive director and two external members picked by the central bank. A government-appointed commission, however, has recommended a seven-member panel composed of the RBI governor, an executive member of the RBI board, along with five external members picked by the government, of which two would be selected in consultation with the RBI.

In addition, the government would send a non-voting representative to policy meetings. The commission also recommends that the RBI governor gets veto power over the committee’s decisions though it should be followed by a public statement.

With inputs from Reuters