The revised draft IFC says inflation target for each financial year will be determined in terms of the Consumer Price Index by the central government in consultation with the RBI every three years. Photo: Pradeep Gaur/Mint
The revised draft IFC says inflation target for each financial year will be determined in terms of the Consumer Price Index by the central government in consultation with the RBI every three years. Photo: Pradeep Gaur/Mint

Govt proposes to take away RBI governor’s veto power in deciding monetary policy

Revised draft Indian Financial Code proposes to give RBI governor an additional vote in case of a tie in the monetary policy committee meeting

New Delhi: The finance ministry has set the stage for a new era of monetary policy formulation in the draft of the Indian Financial Code (IFC) it released on Thursday.

However, the move could potentially spark a confrontation with the Reserve Bank of India (RBI), given that the latest draft proposes diluting the influence of the apex bank, particularly its governor.

The revised draft circulated for public discussion proposes to vest the Union government with the right to appoint four members to the seven-member monetary policy committee (MPC) of the RBI.

At the same time it is taking away the veto power of the RBI governor on monetary policy changes; instead it proposes to vest the governor with a casting vote in the event of a tie in the MPC.

The deadline for receiving comments is 8 August.

The IFC is intended to create a single unified and internally consistent law replacing a large part of the existing Indian legal framework for governance of the financial sector.

Several of the over 60 laws are outdated; there have been dramatic changes in the global financial architecture since the original laws were written, and many of the developments in finance (and the emergence of new instruments) sometimes fall between regulators (or across them), resulting in conflict.

The Financial Sector Legislative Reforms Commission (FSLRC) headed by retired Supreme Court judge B.N. Srikrishna, was constituted in March 2011 to study possible reforms in the financial sector. The commission, in its report submitted in March 2013, suggested a merger of multiple financial regulatory agencies into one overarching authority that would have oversight over the capital market, insurance sector, pension funds and commodities futures trading, except the RBI.

The first draft of the IFC report submitted by FSLRC, too, had proposed to give the RBI governor the right to overrule the monetary policy committee’s decisions.

The modifications to the draft IFC now put out by the finance ministry mainly relate to strengthening the regulatory accountability of financial agencies, removing the provision empowering Financial Sector Appellate Tribunal (FSAT) to review regulations, rule-making and operational aspects of capital controls, monetary policy framework and composition of the MPC, regulation of systematically important payment systems and removing the provision of special guidance.

Monetary policy committee

Currently, RBI does not have an MPC, unlike central banks in many developed countries, and a technical advisory committee comprising RBI officials and a few outside experts decide the monetary policy. However, the RBI governor has the right to veto a decision of the committee.

The report of the expert committee to revise and strengthen the monetary policy framework by RBI deputy governor Urjit Patel recommended that an MPC should have five members with only two outside experts. Currently, the finance ministry and RBI are engaged in discussions to finalize the structure of the MPC.

Finance minister Arun Jaitley, in his February budget speech, had said that the government will move to amend the RBI Act this year to provide for an MPC.

The first IFC draft proposed that in “exceptional and unusual circumstances", if the central bank governor disagrees with a decision taken at a meeting of the monetary policy committee, the governor will have the right to supersede such a decision.

However, the revised draft IFC has withdrawn this clause. Instead, it says, “in the event of a tie amongst the members of the monetary policy committee, the Reserve Bank chairperson will have a second and casting vote".

D. Swarup, former chairman of the Pension Fund Regulatory and Development Authority and a member of the FSLRC that drafted the IFC, said taking away the veto power of the governor was actually a democratization of the decision-making process.

“But the composition of the MPC will be such that it will weigh heavily in favour of the government. But if the government is appointing experts or academicians, it is not necessary that they will vote in favour of the government," he added.

A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd, said a large seven-member committee could create more uncertainty and confusion, given that the inflation-targeting framework and MPC are new concepts in India. On the RBI governor’s veto power, Prasanna said there are arguments on both sides.

“The Urjit Patel committee recommendation on MPC was one-sided in favour of the RBI. But the government is also an important stakeholder," he added.

The latest draft retained the membership of the MPC, including the RBI governor, at seven.

However, while the old draft proposed that two members be appointed by the government in consultation with the RBI apart from three that it can appoint, the new draft proposes that the government can appoint four members of its own while the RBI governor can nominate an employee of the central bank to the committee.

The other member in the committee apart from the RBI governor will be an executive member of RBI. The central government has to appoint its share of four members drawn from candidates short-listed by a selection committee.

Members of the MPC—scheduled to meet once every two months—will serve for four years and enjoy privileges equivalent to those provided to an executive member of the RBI board. 

Each member will have one vote and the decisions of the MPC will be carried by majority. The draft says that each member will have to submit a line justifying their vote and that the decisions of the MPC will be binding on RBI.

Ajit Ranade, chief economist at Aditya Birla Group, said RBI governors have always been of sterling calibre and the veto power reflects confidence in their judgment.

“US Fed committee memberships are for 14 years, much longer than the political and electoral cycle. Shorter duration memberships might be influenced by electoral compulsions. Who is to say that the majority members will not be under the election-related pressures and take decisions which are political, like taking expansionary policy when the real need is that of contraction?," he said

The revised draft IFC says inflation target for each financial year will be determined in terms of the Consumer Price Index by the central government in consultation with RBI every three years.

If the inflation target is not met, then RBI must explain and initiate remedial actions and set out a time period within which the inflation target would be achieved.

In the monetary policy framework agreed by the government and RBI released in February, it was decided that RBI would try to contain consumer price inflation within 6% by January 2016 and within 4% with a band of 2 percentage points for all subsequent years.

An RBI spokesperson did not offer any comment on the issue.

Regulatory reform

The draft also proposes to dilute the powers of the proposed FSAT that will replace the existing Securities Appellate tribunal and hear appeals against RBI and other regulators.

FSAT will not be able to set aside any regulations but can only hear appeals filed by institutions challenging the regulator’s order.

The earlier version of the draft IFC had given the tribunal powers to set aside any regulation and instruct a regulator to issue a new order.

However, the revised code retains the provision wherein decisions taken by RBI against banks can be questioned in the tribunal. So far, only decisions taken by the Securities and Exchange Board of India and more recently, by the Insurance Regulatory and Development Authority of India, can be appealed against in SAT.

RBI governor Raghuram Rajan had opposed the powers given to the tribunal, arguing that the central bank will be reduced to a paper tiger if all its decisions are taken up for review. He had pointed out that once private parties with high-priced lawyers are able to check the regulator’s decision, the regulator risks losing the respect it commands.

“Regulatory bodies are independent autonomous bodies. FSAT should not have the right to change the regulations formed by these bodies. FSAT is a judicial body and its job is to sit in judgement. It cannot become a super regulator," said Prithvi Haldea, chairman, Prime Database. He, however, favoured giving aggrieved financial institutions an option to approach FSAT to challenge an RBI order.

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