Market Maniac

October 4, Here We Come
Sep 26, 2016

The setting up of the Monetary Policy Committee last week creates a new framework from which to judge the independence of RBI from government pressure and interference. This is important because global rating agencies have always recognized central bank independence as one of the pillars holding up their favorable rating of the Indian economy.

Indeed, in developed economies, the issue of central bank independence is so much an article of faith that it seldom comes under discussion. In the US, for instance, there is never any overt tension between the Federal Reserve and the government. Other than recent bluster by Trump, the last time the Fed came under political attack was in the early 1980’s when there were “…widespread protests …due to the effects of the high interest rates on the construction and farming sectors, culminating in indebted farmers driving their tractors into Washington, D.C.” and blockading the Fed’s offices.

In the UK, too, public battles between government and the Bank of England are rare. In Japan, there used to be some tension between MITI (the Ministry for International Trade and Industry) and the Bank of Japan a couple of decades ago, but that is long since history. In the EU, the European Central Bank came under attack about 15 years ago because it’s one size fits all monetary policy wasn’t working – it was, at the time, appropriate for Germany and other slow growing economies in the North but was much too loose for the super-hot Ireland and the near overheating Mediterranean economies; however, rather than questioning the fundamental need for independent setting of monetary policy, this was recognized as more a function of the still-far-from-finished European agenda since there was a single monetary authority catering to several fiscal ones.

Net net, I think it is fair to say that keeping monetary policy away from political expediency is a sound, and widely accepted, idea.

In India, too, we have long honored this separation of powers. The first Indian governor of the Reserve Bank, Sir Benegal Rama Rau, was both the longest serving (1951-59) governor and the only one ever to resign because of his inability to exercise his authority in the face of pressure from the Finance Minister (TT Krishnamachari, or TTK as he was called) and the inability (or unwillingness) of Prime Minister Nehru to bat for the principle.

More recently, we have had a long list of illustrious governors, including Governors Rangarajan, Jalan, YV Reddy, Subbarao, and, of course, Rajan, who have had their run-ins with their respective Finance Minsters but, most of the time, have been able to hold their ground. Dr. Rajan’s rather abrupt departure does suggest that the tension was getting a touch too strong suggesting, perhaps, the principle of central bank independence was coming under question. Indeed, with the government seen as somewhat autocratic in other realms, this issue needs definitive clarification.

Digging a little deeper provides conflicting evidence. For instance, the number of directors appointed to the RBI board has fallen rather sharply in the past 3 years. Under the RBI Act, the maximum number of board members is 21; at the last three AGMs, the number of directors on the board were 12, 17 and 17, down from an average of nearly 19 over the preceding 13 years; again, the number of members of the regional boards were down to 1, 8 and 10 over the past 3 years, from an average of over 16 in the preceding 13 years.

On the one hand, this appears to point to a systematic degradation of the RBI board and, by implication, its governance and management capability. On the other hand, there is some evidence (from senior RBI old-timers) that RBI itself had been keen to eliminate the regional boards for at least the last decade since they really did not add value in a modern technological age. Further, a reading of the RBI Act shows that the RBI Board, unlike, say, the SEBI Board, does not have any mandate to write or approve regulation, nor, like the board of any company under the Companies Act, does it have articulated oversight or control over the management of the institution.

Now, whether the MPC – on which the governor has a casting vote – decides to hold rates unchanged or cut them by 25 basis points or even a front-ended 50 basis points, the real question that will remain is whether the article of faith of central bank independence, a necessary pillar for sustained global investment interest, has been enhanced in any way by this new framework or whether it becomes a subterfuge to enable a pliant RBI to do the government’s bidding.

I would tend to be optimistic on this, but real evidence of this can only be provided by increasing the transparency on the apparent changes in Board structure and, indeed, the functions and importance of the RBI board.

Stay tuned.



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