Indian Financial Code: Defanging RBI?

FINANCE MINISTRY has released a revised Draft of Indian Financial Code (IFC) seeking response from the public. Proposed IFC is an offshoot of recommendations made by Financial Sector Legislative Reforms Commission. The clauses dealing with Monetary Policy function have attracted media attention with critics arguing that Finance Ministry is trying to emasculate RBI in the latter’s exercise of its authority to regulate monetary policy.

Part XI of the Draft deals with RBI. There are 5 chapters (chapters 64 to 68) in this Part. These chapters contain 36 clauses (cl 250 to cl 285). Clauses relevant for this discussion are detailed below with brief comments on their implications.

Clause 250: “The objectives of the Reserve Bank under this Part are to,

(a) formulate and implement monetary policy; and

(b) carry on other activities of a central bank, including ——-“

Comment: Formulation and implementation of monetary policy do not constitute objectives. These are the functions of RBI.  RBI’s objectives ought to be in the nature of, say, maintaining domestic price stability or external value of the rupee.

Clause 252: “The quorum for a meeting of the Reserve Bank Board will be half the total number of members of the Reserve Bank Board, –

(a) at least one of whom must be the Reserve Bank Chairperson; and

(b) in the absence of the Reserve Bank Chairperson —–“

Comment: At present, RBI is headed by the Governor. Is the position likely to be re-designated as Chairperson? (Bank of England has a Governor and the Federal Reserve Board of the US has a Chairperson). What is meant by ‘at least’ one of whom? Is the Ministry envisaging multiple Chairpersons? This seems to be an oversight. ‘At least’ needs to be deleted.

Clause 255: “Determination of inflation target:  Inflation target for each financial year will be determined in terms of the Consumer Price Index by the Central Government in consultation with the Reserve Bank every three years.”

Comment: It is a moot question who should determine the inflation target, the government or the monetary authority?

Clause 256: “(1) The Reserve Bank must constitute a Monetary Policy Committee to determine by majority vote the Policy Rate required to achieve the inflation target.

(2) The Monetary Policy Committee will comprise –

(a) the Reserve Bank Chairperson as its chairperson;

(b) one executive member of the Reserve Bank Board nominated by the Reserve Bank Board;

(c) one employee of the Reserve Bank nominated by the Reserve Bank Chairperson;

and

(d) four persons appointed by the Central Government.”

Comment: By virtue of this clause, the Central Government usurps RBI’s existing authority to decide on Repo Rates. Four out of seven members of the Committee are appointed by the Government and so the majority decision means the Government’s decision.

The rationale for vesting the power to decide on Policy Rates with the central bank is that it will be more objective than the government and it will be guided more by economics than the popularity of its decisions.

Clause 262: “(1) The Reserve Bank must provide all information to the Monetary Policy Committee that may be required to achieve the inflation target.”

Comment: This may land RBI in an embarrassing situation. Very often we come across situations where relevance of any particular information becomes known only after the decision is taken and its consequences felt. Therefore it is better to stipulate that RBI must provide all information that is required by the Monetary Policy Committee.

Relationship between Finance Ministry and RBI is fragile even during the best of times; Finance Ministry need not further stir up the hornet’s nest by amateurish attempts to weaken RBI. 

If this Draft is accepted, the consequences will be a) the Finance Ministry will decide on the inflation target, b) the ministry and its proxies will decide on policy rates and c) RBI will be held accountable for ensuring that inflation targets are achieved. RBI will have accountability without authority.