MPC fared well but the new group should do better, say economists

There is no provision for extension of tenure of external members, and it is likely that the govt will appoint new ones

From September, the six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI) will see a new set of external members as three incumbents-–Pami Dua, Ravindra Dholakia, Chetan Ghate--complete their four-year terms.

There is no provision for an extension of tenure of the external members, and it is likely that the government will appoint new ones. It is important to note that the appointments are left to the government, and the RBI has almost no say in that. The RBI contributes with three members in the committee, and if there is a tie, the RBI governor has an additional vote to decide on rates. That situation has not arisen yet.

Economists say while the MPC did a fair job on setting rates and protecting its inflation mandate, and certainly a transparent one at that, certain fine-tuning can be done to the process even without changing the RBI Act. Some changes could take substantial change in the Act, but that can be done to make the system further efficient.

The first change could be the kind of external members that constitute the committee. The three external members now are all academicians, but rates could be best decided by the diverse set of experts who have more ears to the ground or are well-known for their work on monetary or macroeconomic matters.

“The policy decisions are framed from the borrowers’ perspective, there is no lender or depositor input in this. There can be one commercial banker, one corporate participant and one representative of depositors, and let there be an external economist of renown. There is no harm if the MPC becomes a seven-member committee” said Madan Sabnavis, chief economist of Care Ratings.

Another senior economist, who did not want to be named echoed a similar sentiment.

“In the MPC, there has been not much of a divergent view. An ideal MPC should have a stalwart macro-monetary or fiscal economist. The deliberations could have been rich if the MPC brought their own forecast, and not depend upon the RBI models,” said the economist. He cited the example of Federal Reserve external member Alan Blinder who brought his own forecast and frequently countered the Federal Reserve.

There should be at least one economist or policy practitioner of the stature of Shankar Acharya, Ashok Lahiri or Rakesh Mohan who could give a different perspective, economists say.

Of course, that is not to say that there has been no divergence of opinion. That happened and even among internal RBI members. For example, former deputy governor Viral Acharya did differ with governor Shaktikanta Das, or Michael Patra as an executive director was decidedly hawkish when other members sounded dovish. Among external member, Ravindra Dholakia’s views differed than the rest, especially under Urjit Patel when rates were not coming down in tandem with the inflation. Dholakia wanted deep rate cuts, and often took the opposite stance of Michael Patra.

The MPC’s mandate was to keep inflation contained within 2 per cent to 6 per cent and anchored around the mid-point of 4 per cent. This they did for the larger part, but it was not easy considering the cost-push inflation was beyond the RBI to manage.

Rupa Rege Nitsure, group chief economist of L&T Finance Group, and one of the members of the Inflation Targeting Monetary Policy Framework, noted that the “politically induced component of inflation was very high” throughout the period 2008-2013. Food prices remained stubborn due to ad hoc increases in MSPs of foodgrains. While the MPC was supposed to control the demand-pull inflation, the generalised inflation pressures created by food prices were very high for a fairly long period of time.

When the inflation started easing due to economic weaknesses, not all MPC members were on the same page. As a result, the inflation projections were off the mark in a few policy reviews. “The MPC tended to overestimate inflation impulses and underestimate growth weaknesses. But they remained truthful and faithful to their rule-based framework, and were not afraid to change their stance quickly to readjust with the changes,” Nitsure said.

The MPC did a “great” job, brought in complete transparency to the process, and boosted the trustworthiness of the country in the eyes of the foreign investors. It also brought discipline in the market participants, said Nitsure.

But economists also noted that in India, the MPC is not as powerful as those in other developed countries.

“The MPC have done a decent job given the mandate. The problem has been RBI has done several things like demonetisation, Operation Twist, Reverse Repo cut, Quantitative Easing, etc. which have interest rate implications but the MPC had no say,” said Amol Agrawal, Assistant Professor at Ahmedabad University.

Therefore, the RBI Act itself has to be redone, Agrawal said, adding, the MPC members should have put out a dissent note on measures taken outside of their meetings.

According to Sabnavis, somewhere the MPC lost the rule-based flavor of their mandate. For example, RBI was seen cutting rates when inflation was falling, but rates were left unchanged when inflation inched up. Besides, the 4 per cent inflation mandate is not a feasible target when India’s average inflation rate, before the MPC, remained at 5-6 per cent.

“There should be Parliamentary intervention when whether growth should also be a target. The government must make it very clear that the MPC will have to look at both growth and inflation, and not just inflation,” Sabnavis said.

While inflation is the sole mandate of the MPC, RBI governor Shaktikanta Das has time and again stressed that growth is an important mandate too for the RBI. That is, however, not clear in MPC mandate.