RBI’s conflicting objectives complicate issues of independence | analysis | Hindustan Times
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RBI’s conflicting objectives complicate issues of independence

analysis Updated: Jul 25, 2015 02:30 IST
Hindustan Times
Indian Financial Code

India's attempt to modernise a clutch of archaic financial laws into a contemporary code can involve painful adjustments.

The latest draft of the Indian Financial Code (IFC), which the government released on Thursday, effectively seeks to take away the Reserve Bank of India (RBI) governor’s overriding powers on interest rate decisions.

The government has, instead, proposed to give an additional vote to the RBI governor in case of a tie in any meetings of a yet-to-be set up monetary policy committee that will decide on lending rate cuts and hikes.

The revised draft also drops a clause that allowed the RBI governor to overrule a majority ruling of the panel if he or she disagreed with it.

These proposals have triggered fears that the move, if adopted, could potentially dilute the central bank’s status as an independent, autonomous monetary authority.

The primary duty of most central banks in the world is to influence the flow of money and credit. That’s not quite the case with the RBI which juggles multiple objectives.

It anchors the monetary policy guided by current and expected inflationary trends. It is also a watchdog for banks, it prints money and prevents volatility in the foreign exchange market. Besides, it also acts as the central and state governments’ banker and lender of last resort.

Some of these objectives are liable to generate conflicts of interest. For instance, as the government’s merchant banker and the sole regulator of sovereign bonds, its objective is to keep interest rates low. But, if inflation is galloping, the central bank is expected to keep interest rates at high levels to stymie demand and cool prices. The simultaneous occurrence of such situations can often force the RBI to make a difficult choice between two equally important goals.

The idea of setting up a monetary policy committee — a joint panel of the government and the RBI headed by the central bank governor — was precisely driven by the objective of dealing with such conflicting goals.

The government and the RBI have already agreed to adopt a monetary policy framework, which will make taming inflation the primary priority of the RBI’s policy decisions.

Under the new system, billed as the biggest monetary reform measure in a generation, the RBI will set a new retail inflation target of below 6% by January 2016 and 4% by March 2017.

While this approach has now become standard international practice in many mature economies, the risk lies in the executive creeping into the regulator’s domain eroding its autonomy. It would be prudent to clearly define the boundaries and powers, well before it reaches a flashpoint.