One point in the draft Indian Financial Code (IFC) has attracted considerable media comments: the composition of the Monetary Policy Committee (MPC), and whether the Governor can act contrary to the majority view of the MPC. Much of the media has been critical of two specific provisions:
- That the government should nominate a majority of the members; and
- That the Governor has to abide by the consensus/majority view of the MPC.
Critics feel that the proposals, if implemented, would erode the autonomy of the central bank in framing monetary policies. It was good to read the Governor’s comments on the (non)issue: committees would be less prone to mistakes, and provide policy continuity which an individual cannot.
If the inflation target is not achieved, the Governor is expected to send a report to Parliament on the issue explaining why the target could not be achieved and what he proposes to do. This seems to me to be parallel to the procedure currently followed in the UK. It is debatable of course how useful such reports are. I recall a Financial Times editorial describing one Bank of England report as 25 pages saying nothing! And no wonder. Too many factors which significantly affect consumer price inflation are outside the control of monetary policy: supply side influences like global commodity prices, food inflation which depends partly on the monsoon and partly on the minimum support prices, export bans or minimum export prices on specific food items, etc.
In the media debate, one point in the draft IFC has been generally overlooked: “The objective of monetary policy is to achieve price stability while striking a balance with the objective of the Central Government to achieve growth.” This in effect negates one important recommendation of the 2008 committee on financial sector reforms, chaired by Dr Rajan (“A 100 Small Steps”). It had recommended that the RBI should target a single objective – low and stable inflation – rather than juggling with multiple mandates (the exchange rate and capital flows, growth, etc.
I believe that a single point agenda for the central bank, as advocated in the Rajan Committee Report, is not a realistic proposition in today’s political economy. For example, “commercial” banks are expected to give priority sector advances at lower than market rates – and recently opened crores of Jan Dhan Accounts, surely not a very “commercial” proposition. The sovereign government itself has to strike a balance between conflicting objectives: fiscal deficit and the welfare or investment needs of the economy, for example.
The ground reality is that there would, at times, be a conflict between price stability, needing high interest rates, and growth needing lower rates, at least in the short run: to be sure, it is often argued that there is no conflict between low inflation and growth/employment “in the long run”. To quote from Dr. Rajan’s Fault Lines, he believes that “The long-run level of employment of the economy would be determined by factors like the business climate, incentives to innovate, and the ability of firms to hire or lay off workers easily, not by inflation.” The only incontrovertible fact is that, as Keynes said, in the long run all of us are dead anyway!
To quote another example in terms of the policy ambit of the central bank, an overvalued exchange rate would reduce the prices of imports and help curb inflation; it can also lead to slower growth and employment – and may even lead to a balance of payments crisis as many economies have found (Mexico 1994-95, Argentina 2000-01, to mention only two.) Surely, both the values of money, domestic and external, need to be managed by the central bank – keeping in mind that there have been more crises in the last 100 years originating in the latter than the former!