Last week, the finance ministry published a revised draft of the Indian Financial Code (IFC), which incorporates feedback received on the initial version published in 2013. While this is intended to be a comprehensive and integrated legal framework for the country's financial sector, most of the response to this draft has been focused on what it proposes for the new monetary policy committee framework. While there is an agreement in principle between the ministry and the Reserve Bank of India on setting up a committee, there are obviously significant differences between them on its composition and distribution of power. According to the report of the Urjit Patel Committee, the monetary policy committee should consist of three RBI insiders and two outsiders, who are appointed by the RBI, thus giving the ministry no say in the composition. It would be a Herculean leap of faith to expect the ministry to accept this formulation. The counter, according to the first draft of the IFC, was to have five external members appointed by the ministry and to provide the governor a veto to maintain the balance of power. The latest version reduces the number of external members to four, still keeping the RBI representation in a minority, but takes away the governor's veto power. All it does is to give him or her a casting vote in case of a tie.
As expected, this has evoked strong reactions on both sides. Some see it as an unwarranted capture of the process by the ministry, in violation of both the spirit and the formality of an inflation targeting framework. How can the RBI be held accountable for a target, they ask, if it doesn't have a majority position in the committee? Others see it as a necessary defence against a potentially maverick RBI governor, ensuring that a robust alignment between policy positions is maintained. As things stand, there is presumably room for convergence, with the Chief Economic Advisor stating that this formulation did not necessarily reflect the views of the ministry. What would be the best arrangement?
A disconcerting aspect of the positions of the two organisations on the relative balance of power within the committee is the apparently low level of mutual trust. In reality, both the formulations have some obvious disadvantages. The RBI's proposal does not significantly change the power structure from the current one, which gives the governor complete discretion over monetary policy decisions. It does not represent a genuine collective decision-making process such as is in place in modern economies. But the IFC formulation depends crucially for its effectiveness on the selection of the external members. If some or all of them are appointed on the basis of their loyalty to the ministry, their decisions in the committee could become a means for the ministry to consistently overrule the governor. This might facilitate the short-term objectives of the ministry but could undermine the long-term goal of credibly containing inflation. Whatever middle ground is to be achieved must ultimately be based on a foundation of mutual trust. Both sides need to work on re-building this. While this is happening, it would be pragmatic to have a structure with an equal number of votes and veto power for the governor. After all, the ministry always has the power to appoint a new governor.