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Two former finance secretaries involved in shaping the monetary policy framework have criticized the Reserve Bank of India for setting the reverse repo, the rate at which the central bank absorbs excess liquidity, independently of the rate-setting panel.

The two former officials said the move encroaches on the remit of the six-member monetary policy committee (MPC) mandated by Parliament to set interest rates. But, RBI governor Shaktikanta Das has defended the central bank’s decision, arguing that the decision on the reverse repo is not in the MPC’s domain.

However, in a speech on Thursday, deputy governor Michael Patra said RBI had been forced to reduce the reverse repo as an “out-of-the-box response" aimed at easing financial conditions in “pandemic times".

RBI governer Shaktikanta Das
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RBI governer Shaktikanta Das (Photo: Mint)

To ensure that the monetary policy reforms are not rendered redundant, the finance ministry should issue a clarification and, if required, amend the RBI Act to prevent the central bank from setting the reverse repo rate inconsistently with the MPC’s decision on the repo rate, the former officials said.

Former comptroller and auditor general of India Rajiv Mehrishi, who, as finance secretary, signed the Monetary Policy Framework Agreement between the government and RBI, said: “To my mind, reverse repo rate is integral to monetary policy…it is very much a part of the “policy rate" referred to in the agreement signed between RBI and MoF (ministry of finance) in 2015".

Arvind Mayaram, who was finance secretary before Mehrishi, said, “The reverse repo is not independent of the repo. The two are linked. Once the repo is set, the reverse repo is determined automatically. It is purely nit-picking for RBI to interpret the amended RBI Act to mean its setting of the reverse repo is not bound by the MPC’s decision on the repo". Mayaram worked under finance ministers P. Chidambaram and Arun Jaitley to formalize the new MPC framework on recommendations given by a RBI panel headed by former governor Urjit Patel.

The MPC framework is aimed to reduce RBI’s discretion to set monetary policy. It envisages that the RBI governor ceases to be the singular deciding authority on policy rates. Instead, the MPC’s decisions were made binding on the central bank through amendments in the RBI Act.

However, in an interview last month, RBI governor Das told The Hindu Business Line that “it (the reverse repo rate) is not in the MPC’s domain. It is RBI that decides the reverse repo rate". The statement followed after minutes of the August 4-6 MPC meetings showed Jayanth R. Varma, a non-RBI member of the MPC appointed by the Modi administration, expressed disagreement with the level of the reverse repo rate. Thereafter, in an interview with the Business Standard, Varma said the reverse repo rate at 3.35% has become the effective interest rate in the economy: “This 4% (repo rate) has, sort of, become irrelevant... The easing cycle has lasted for so long, and we have still not got the economy on to a robust growth path. If I can borrow money at 3.35% for one month, that’s not going to persuade me to set up a new factory."

In his defence of RBI, Patra said the suggestion to adjust the reverse repo rate asymmetrically relative to the repo rate was from an external member of the MPC.

Mint spoke with two other former government officials who were directly involved at different stages of securing the MPC agreement with RBI and the amendments in the RBI Act through Parliament for operationalizing the new framework. Requesting anonymity, one said the government must issue a clarification to state unambiguously if or how much discretion RBI has about the reverse repo rate. The official further said he was very clear that the reverse repo rate falls within the MPC’s remit, but the government needs to amend the Act again to state this unambiguously as the RBI’s legal department seems to be interpreting it differently.

The second person, who led technical discussions in the ministry before the amendments were drafted, said on the condition of anonymity that the Act, in fact, allows the MPC to vote on the reverse repo rate, and that vote is binding on RBI.

In an article published last year in The Indian Express, former RBI governor Patel, who is credited with designing and operationalizing the new framework in the central bank, wrote: “Lately, RBI has moved this (reverse repo) rate progressively lower than the policy rate; recently, it has done so outside of the MPC meeting cycle and not as part of the MPC resolution. The net effect is that market interest rates are being increasingly controlled by RBI rather than the MPC."

He further wrote: “The spirit of MPC framework enshrined in the RBI Act is being violated. It is unclear how the MPC can be expected to satisfy its legal mandate if what it seeks to achieve via setting of the policy rate is in conflict with, or compromised by the RBI’s liquidity management."

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