MPC: Will it do good or merely weaken RBI Governor?

Recently, Department of Economic Affairs secretary Shaktikanta Das tweeted 'Amendments to RBI Act for Monetary Policy Committee (MPC) and connected rules notified. This is one step closer to its formation and operationalisation, which must have reverberated long and hard in Mumbai's RBI headquarters which overlooks the dockyards. Imperilling the autonomy of the Reserve Bank of India seems to be  the favourite pastime of Governments in power as they seek to take control of the interest rate regime.

Two events in more or less rapid succession have left no doubt in one's mind that the RBI is being undermined. The maelstrom over incumbent Governor Raghuram Rajan's continued tenure is not part of this discourse. Ex Governor D. Subba Rao's memoirs and his interviews thereafter have certainly brought the central bank and its role under the public microscope.

It is well known now that successive finance ministers have had a frosty relationship with the man sitting in Mumbai's Mint Street. Inflation targeting versus growth imperatives has been the single biggest determinant in these past few years of spiking inflation and low growth. Given that the high inflation in India is a function of high priced  imported crude and inordinately exorbitant local food prices, the RBI was forced to use monetary tools like interest tightening mechanisms to suppress inflation. In the absence of strong supply side interventions and a distinct distaste for governments to deal with these long pending issues by fixing things, the RBI could only take recourse to rate hikes to subdue the inflation genie. This automatically meant that industry was agitated and manufacturing suffered.

A conspiracy theory doing the rounds after Subramanian Swamy was used like a stalking horse by the ruling dispensation to get rid of Governor Rajan was that industrial houses in Mumbai were furious with him for not just cutting off credit lines from Indian banks, but equally with his stubbornness over not cutting interest rates in a much more benign inflation environment. Between an unflinching inflation watch and the non performing assets bogey, Rajan's popularity with India Inc hit a nadir. Nor was the new government happy with the same inflation gazing since it wanted to show growth as part of its development mantra. But as I mentioned this is not about how Rajan's thinly veiled allure faded, it is about how the new government wants to reshape the narrative.Perhaps something more significant has eluded all of us as it swam by before us like a submarine.

This government-central bank tension has been inherent for sometime now. The fact that ex-Guv D. Subba Rao, a P. Chidambaram appointee after serving as finance secretary under him, chose to take the extreme step of writing his memoirs is by itself a shocker for Central Bankers don't do tell all books. Subba Rao was very much an insider who has gone rogue or is it that he has decided to set the record straight once and for all. That Subba Rao has gone ahead and made adverse statements against both Pranab Mukherjee and P. Chidambaram gives you a sense of the intense pressure that may have been exerted on him. By ignoring Subba Rao at an event in Mexico, P. Chidamabaram probably convinced the former Governor that the relationship was 'impaired'.There is also another instance recounted in the book where Mukherjee jumped at the gun at an industry interface by telling those gathered that the Governor will have some good news for them.

When Subba Rao cut the repo rate by 50 bips after 13 incessant hikes, the former Governor writes, "Finance Minister Mukherjee was scheduled to address a business chamber in Delhi, an hour before the policy release time. As he was entering the meeting hall, he commented informally to the corporates and the media that surrounded and greeted him that "the governor will shortly give you good news". This was most inappropriate and indiscreet. I am positive that the Finance Minister did not intend any mischief; nor did he want to undermine the RBI. I think he was just being naive, overanxious to be the bearer of good news to the corporates in the midst of widespread criticism of policy paralysis in the government hoping that some of the credit for this would rub off to him."  These are strong words for someone who should be subservient. Subba Rao has finally revealed what no other central banker in India has chosen to do which is articulate the state of taut anxiety between Mukherjee/Chidambaram and him personally.

The RBI Governor's primary objective is to focus on price stability and capital flow management. It is now clear that both Mukherjee and Chidambaram wanted rate cuts to revive investments. Subba Rao writes that Mukherjee's stance was straightforward; that the Reserve Bank should ease on the interest rate to support growth.. Chidambaram, on the other hand, was more nuanced; he believed that I should cut rates in acknowledgement of his efforts at fiscal consolidation and would assert his arguments more firmly and forcefully.. My refusal to fall in line had evidently upset Chidambaram enough to do something very unusual and uncharacteristic — to go public with his strong disapproval of the Reserve Bank's stance." On the issue of re-appointment of two deputy Governors — Usha Thorat and Subir Gokran — too, Rao faced issues with both Mukherjee and Chidambaram.

Against this backdrop, the Government's decision on the creation of the Monetary Policy Committee (MPC) by notifying changes made to the Reserve Bank of India (RBI) Act is extremely pertinent. A six-member panel monetary policy committee (MPC), chaired by the RBI governor, will now take decisions on interest rates. As part of this emasculation of RBI process, the governor will not enjoy a veto power to overrule the other panel members, but will have a casting vote in case of a tie. The Finance Bill, 2016 contained an amendment to the Reserve Bank of India Act of 1934 to give a statutory basis to the monetary policy framework. Last year, the government and the Reserve Bank of India had agreed to adopt a monetary policy framework, which will make taming inflation the primary priority of the central bank’s policy decisions. The committee will now set interest rates to keep retail inflation within targets. Inflation targets will be set once every five years. Further, the government will nominate three eminent persons to the MPC. No government official will be nominated to the MPC. The other three members would be from the RBI with the Governor being the ex officio Chairperson. The Deputy Governor of the RBI in charge of the monetary policy will be a member, as also an executive director of the Central Bank.

The RBI will set a new retail inflation target. The RBI uses monetary tools to stymie demand and cool prices. In times of weak growth and low prices, it is usually expected that the central bank will cut interest rates to prod companies to invest, add capacities, hire more, and prompt people to spend on houses, cars and other goods. By bringing value and transparency to monetary policy decisions, the Govt has moved into RBI's sacrosant space. The committee is expected to meet four times a year and intimate its decision making to the public at large.

The testiness between the central banker and the finance minister goes well beyond creative and intellectual tension. It assumes the role of a turf war as both sides jockey to protect their territory. The central banker wants to remain at the vanguard of price stability while the political office of the finance minister wants to pursue growth imperatives. It begs the question of jurisdictional and operational autonomy and where it lies? With monetary policy having been taken away by the Government, the enfeeblement of a relatively autonomous RBI has begun. It is a dangerous precedent where erosion of public and constitutional institutions has been attempted by creeping design. The Supreme Court-Government jurisdictional war is part of this enterprise.

The primacy of the independence of the central bank in an emergent economy like India is vital, it cannot under any circumstances be enervated. Politicos have their own pressures and issues, yes they want growth, but more than that they want to remain unchallenged. The amendment to the RBI Act and tinkering with monetary policy is a first and it shows us how quickly politics has overtaken economics in this country. What is now a matter of conjecture is that when India faces its next inflation litmus test, what will the government do and how will an equity eroded RBI respond since it doesn't have any teeth left? India remains a rain fed economy, unseasonal rains have caused havoc in the past, upsetting the entire demand side economy.

With Governments unable to ramp up supply side interventionist tools, the fall back has always been interest rate tightening. Food inflation has remained a function of regular supply of fruits and vegetables. In India, rice and wheat comprise 70 percent of agricultural produce by area, but less than 25 percent by value. Government data shows that the consumption of wheat and rice has been declining around 1 to 2 percent in both urban and rural India, while the demand for fruits and vegetables has been rising by 2 to 3 percent annually. Wheat and rice are supported by hikes in Minimum Support Prices which make them much more lucrative than growing highly perishable fruits and vegetables. These anomalies and production risk are the single biggest imponderables on the supply side. And will remain so, till the Government fixes what is broke for years.