RBI governor might get veto in price stability mechanism

Prime Minister Narendra Modi's administration has proposed giving the Reserve Bank of India (RBI) governor veto power over a new monetary policy council that for the first time would focus on price stability as its main mission, people with knowledge of the matter said.

The finance ministry proposal calls for the formation of an eight-member committee headed by the RBI governor and a deputy that includes one government nominee with no voting rights, according to two people who asked not to be identified because the discussions are private. The RBI governor, a senior finance ministry bureaucrat and an outside expert will help pick the other five members, they said.

The finance ministry's proposal is in response to January recommendations from RBI on the most sweeping overhaul to monetary policy since the waning years of British colonial rule. Modi's government backs RBI's proposal to make Consumer Price Index (CPI)-based inflation the "predominant objective" of monetary policy for the first time, the people said, while also saying it should promote economic growth and employment.

The proposal differs from the RBI panel backed by Governor Raghuram Rajan, which called for a five-member committee in which the majority would determine the policy decisions, with the central bank chief breaking a tie if a member was absent. Under that proposal, members would include the governor, his deputy and two outside experts picked by them, along with an RBI official handling monetary policy.

The changes are a compromise with another set of recommendations made last year by a finance ministry-mandated panel that called for a seven-person committee with five external members appointed by the central government, according to Prasanna Ananthasubramanian, chief economist at ICICI Securities Primary Dealership in Mumbai. Under that proposal, the governor would have power to override the committee.

Discussions between the government and RBI are continuing, the people said. Both plan to sign a framework agreement in the next few months that takes effect in the next financial year beginning April 1, they said. D S Malik, a finance ministry spokesman, declined to comment on discussions related to the monetary policy framework.

While the adoption of a government-endorsed inflation target would enhance its credibility, the failure to change the underlying legislation governing the Reserve Bank of India dilutes its effectiveness, Ananthasubramanian said.

"At any point, a future government can change it," he said by phone from Mumbai. "To that extent, there will be some uncertainty over inflation targeting in India." Under current rules, the governor alone makes policy decisions with input from an advisory group and central bank officials. Rajan has held the repurchase rate at eight per cent for the past four meetings after adopting the RBI panel's recommendation to bring down CPI-based inflation to six per cent by January 2016.

Rajan said last month the central bank was on pace to hit that target, discounting an RBI model that said seven per cent was likely. India's retail inflation of 7.8 per cent is the highest among 17 Asia-Pacific economies tracked by Bloomberg, and compares with two per cent in China and 4.53 per cent in Indonesia.

The finance ministry proposal said the CPI target would be agreed to during consultations between the government and central bank, the people familiar said. The central bank had proposed a target of four per cent with a plus-or-minus two percentage point band.

PATH-BREAKING PROPOSAL

| A finance ministry proposal calls for the formation of an eight-member committee, headed by the RBI governor, with a deputy and a government nominee with no voting rights, with veto power to the RBI chief
| The RBI governor, a senior finance ministry bureaucrat and an outside expert will help pick the other five members
| The finance ministry's proposal is in response to January recommendations from an RBI panel on the most sweeping overhaul to monetary policy since the waning years of colonial rule
| Sources say Modi's government backs RBI's proposal to make Consumer Price Index (CPI)-based inflation the "predominant objective" of monetary policy for the first time