Monetary Policy Committee: Both the Government and RBI have got it wrong

With the RBI and Government tugging at extremes, the middle ground is better

 RBI Watch                                                                                    Monetary Policy 2015-16

I had written on this subject on October 22, 2014. Please read this blog to get the full picture.

I place below the relevant section.

"What should be the process for deciding the course of monetary policy?

The Urjit Patel Committee suggested moving the responsibility from the Governor of the RBI to a Monetary Policy Committee (MPC). This makes sense.

The Committee suggested that the MPC should consist of the Governor, a Deputy Governor, an Executive Director of RBI, and two external members picked by the RBI. My view is that to start with, we need a small MPC of four members consisting equally of internal and external members. I suggest two external members, both persons of independent standing with experience in fields such as of banking, finance, industry (agriculture or manufacturing) and sociology. Government should pick these members in consultation with the Governor.  The two internal members will be the Governor and a Deputy Governor in charge of monetary policy at the RBI. In the event of a tie, the Governor should cast one additional vote.”

Last week the government released a revised version of the draft Indian Financial Code. Clause 256 page 122 covers the detail regarding the composition and voting by members of the MPC. The clause indicates that the MPC would consist of seven members - four appointed by Government and three from the RBI. The MPC will determine the policy rate by majority vote.

I hold to my view, which is that the MPC should consist of an equal number of members from within and outside the RBI. 

Why should the RBI have a majority in the MPC? Surely, there are people with expertise outside the RBI on monetary policy, and it makes for better decision making if such members are equally represented on the MPC. On the flip side, what justification does government have for the MPC to have a majority of government appointed members? I do not see any grounds for this, irrespective of the yardstick that is used – expertise or responsibility. It is the MPC's function and not the government's to set the policy rate.

I do believe, at this juncture, that the Governor (the IFC refers to a new title: chairperson!) of the RBI should be given an enhanced power to cast an additional vote in case of a tie in the votes, i.e all four members vote, and should there be a tie, then the Governor casts his additional vote.

Why? The intricacies of inflation targeting is in its infancy in India, the concept of an independent committee setting interest rates is yet to be institutionalised, and expertise in both monetary policy and markets is scarce to find. In this scenario, I would argue that the Governor, an individual picked for his/her superior expertise on monetary matters and professional integrity – whose performance, all said and done, will be judged by whether he or she achieves the inflation target, although it is the MPC which is formally responsible - should be given an enhanced voting power at the MPC. 

Can the same argument not be used to give the Governor the power of veto? I believe this is not the right governance in a public institution of high standing consisting of experts. If the Governor is in a minority in one particular round of voting at the MPC, then it is only fair for the Governor to accept his position.