RBI Governor’s Role in Deciding Interest Rates Diluted!

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The RBI governor will no longer have the final say on monetary policy! The finance minister during his budget speech had said, “The RBI Act 1934, is being amended to provide a statutory basis for a Monetary Policy Framework and a Monetary Policy Committee through the Finance Bill 2016”.

Yesterday in a statement, the government announced the constitution of the Monetary Policy Committee (MPC).  Outgoing RBI Governor Raghuram Rajan has always been supportive of a committee-based decision making.

It is important to remember that the MPC was recommended by the “Expert Committee to Revise and Strengthen the Monetary Policy Framework” as early as Jan 2014 (before the BJP came to power).

While the MPC will dilute the power of the governor, it is meant to aid, not curb. In March 2016, while delivering the  first Ramnath Goenka (creator, Indian Express) lecture Rajan had said:

“The RBI’s inflation-focused monetary framework will be strengthened by the constitution of the monetary policy committee mooted in the Finance Bill.

While the RBI Governor will no longer be able to set monetary policy unilaterally, I believe shifting the decision to a committee is in the economy’s interest.

Not only will a committee aggregate multiple views better than an individual can, it will offer more continuity, and be less subject to undue pressure. I believe the monetary reforms of this Government will stand out as one of its signal achievements.”

Spoken like a true academic! A year or so back, in a press conference he had said

  • “A committee can represent different viewpoints, and studies show that its decisions are typically better than an individual’s.”
  • “Spreading the responsibility for the decision can reduce the internal and external pressure that falls on an individual;”
  • “A committee will ensure broad monetary policy continuity when any single member, including the Governor, changes.”

The government believes that “a  committee-based approach will add a lot of value and transparency to monetary policy decisions”.

Member of the MPC

  1. RBI Governor (ex-officio Chairperson)
  2. Deputy Governor, RBI
  3. one officer of RBI.
  4. Three economic/banking/finance/monetary policy experts  (full time, with no other employment of conflict of interest)

The ‘other 3’ shall be appointed by the govt on the recommendations of a Search-cum-Selection Committee headed by the Cabinet Secretary.

The MPC will meet each quarter and decide the interest rate. The first meet in Aug will be chaired by Rajan (his last).

The expert committee to revise and strengthen monetary policy was chaired by Urjit Patel. It is in this report, the MPC and quarterly reset of small saving (SS) interest rates were recommended.

Someday I hope the SS rates would also come under the purview of the MPC and the rates would be strictly reset as per formula (not done this quarter).

The report says the MPC would be accountable if they fail to contain inflation between 2% to 6% and will have to publically state reasons for failure to do so, along with remedial measures.

Does the govt now has more influence on monetary policy? Clearly yes! From a position of overriding the recommendations of the RBI technical advisory committee, the governor now only has an extra vote in case of a tie in the MPC. This is a major dilution but can be a good move for the county considering all members are experts.

Next time a charismatic RBI governor wants to leave, there would hopefully be much lesser hue and cry!

What do you think? Good move or bad?

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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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  1. As long as the intensions are good. Look at the status of election commision ie after diluted to have 3 instead of 1 before.

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