Raghuram Rajan’s Successor Is A Committee

Heard of the Monetary Policy Committee? It’s going to be the biggest change in the Indian banking system

ByMeghnad S
Raghuram Rajan’s Successor Is A Committee
  • whatsapp
  • copy

Now that Raghuram Rajan’s term is ending on September 4, it’s time to talk about his successor: the Monetary Policy Committee (MPC).

You heard that right, a whole committee, headed by the incoming Reserve Bank of India (RBI) Governor, Urjit Patel, is set to succeed Rajan.

Ever since Rajan announced his resignation, the media has been divided into two camps. One has mourned the loss of a great visionary central banker who was putting ‘sex back in the sensex’, while the other excitedly discussed who will replace Rajan. The second group has been pretty entertaining.

“Is it going to be Arundhati Bhattacharya? The first woman RBI chairman! That would sell, boyz, that would sell well indeed!”

“Is it going to be Subramanian Swamy? That wily little fox has been planning it all along!”

“Is it going to be Pahlaj Nihlani? He makes so many interesting cuts, probably he’ll be good at cutting interests too!”

“Is it going to be Tanmay Bhat? He can then announce interest rate cuts over Snapchat. He’ll snap the economy in the Bhat and bring it back to shape!”

(Pun intended)

After much intense deliberation and nail-biting moments, it’s been announced. The new RBI governor is going to be Urjit Patel, previously the deputy governor of RBI. This piece is not about him though.

First up: What does an RBI Governor do exactly?

Before we start talking about the epic change looming round the corner, let’s go over what the RBI Governor does.

Think of the RBI as a big bank that lends to other smaller banks; those banks in turn lend to you. Commercial banks also get their own money through deposits (from people like you and me) and then lend it to people (like you and me).

The governor takes a call on what interest rate the RBI will charge to the banks they are lending to and in turn, banks add a tiny percentage of their own to that interest and give out loans. The difference of interest rates between deposits and lending is where the banks make the profits. Simply put, the central bank keeps control over how cheap or expensive loans in the market will be.

The governor also sets the Statutory Liquidity Ratio (SLR) for banks. That’s basically the amount of securities (gold, bonds, assets) banks need to have to disburse loans of a proportional amount.

Apart from setting interest rates, the governor is also a sort of a Bank Manager. He keeps the machine running smoothly. He decides how much money is to be printed in what denominations. He gets to put his supercool signature on currency notes. He makes sure the cheques get cleared, fair exchange of funds happens between banks and basically keeps a watch on the banking sector through regular audits.

The governor is in-charge of maintaining order in the foreign exchange market and making sure the country is working towards the goals set by the Foreign Exchange Management Act (FEMA). He also has the power to issue directions to banks, like the recent one in which Rajan ordered a clean-up of balance sheets and declare Non-Performing Assets (NPAs).

Basically, the RBI governor is someone whose day in the office involves feeling like this:

The one single job of the RBI governor over the past few years has been to resist the pressure of successive governments to reduce interest rates too much. Or, at least, that is the part of his job that traditionally gets him in the news.

So the RBI Governor is an epic Finance God that gets to mess with the government, right? RIGHT?

Actually, the governor actually has the job of ensuring economic stability. He is supposed to think long-term, ensure that the citizens don’t go on an insane spending spree and create artificial financial bubbles that will burst later and bite ‘em in the ass. For example, the 2008 financial crisis in America, which happened because citizens were like:

The government, on the other hand, is a creature with a life of five years. In those five years, they are desperately trying to woo the voters and get them to vote for the same political party in the next election. What would make people happier than having more money to spend? Ergo, cheaper and more accessible loans!

The government of the day will keep asking the RBI Governor to lower interest rates so that there is more money flooded in the market (“Bubbles? What bubbles? We’ll deal with them later!”). The RBI Governor refuses most of the time because propping up an economy on the shoulders of a monster called ‘debt’ is… well… a TERRIBLE idea.

Debate? What debate?

The Finance Bill, 2016, which was passed in the last budget session of Parliament, had a controversial amendment to the FCRA act (Clause 233) that allowed foreign funding to political parties. That’s not all. It had another amendment to the Reserve Bank of India Act (Clauses 216 to 230), which created an entity called Monetary Policy Committee (MPC).

Weirdly enough, there was ZERO debate in Parliament about this massive change that is about to happen to our banking system. The amendment was included within the Finance Bill which was introduced by the Finance Ministry, while the RBI Act comes under the jurisdiction of the Home Ministry.

It’s a true mystery how such an amendment was allowed to be passed without any fuss!

What is the MPC?

Earlier, the RBI Governor was the whole and sole authority to decide interest rates. He could veto anything that he thought doesn’t benefit the Indian economy. It was a dictatorship and there was no way around it. Now, the MPC will be the one setting rates and making fiscal policies for the country.

The MPC will have six members: three from the RBI and three eminent personalities appointed by the central government. The RBI representatives will consist of the governor (Chairman of the MPC), deputy governor & one officer nominated by the RBI central board.

The three other members will be appointed by the Central Government at the recommendations given by the following people:

Mind you, these are recommendations. The central government will be the one appointing these members. Each member gets one vote. If there is a tie, the RBI Governor gets the casting vote:

Every member has to give a written statement explaining why they voted in favour/against a resolution. However, all proceedings of the Monetary Policy Committee shall remain confidential:

These are the bare bone facts that I have presented to you.

The ramifications of the MPC are huge. And that’s putting it mildly.

The MPC Effect

Most global banks have this process of having a committee to decide rate and monetary policies. In the United States of America, the Federal Open Market Committee has seven board members, all of whom are appointed by the President for a period of 14 years. In England, the MPC has nine members (five from the Bank of England and four appointed by the Minister of Finance).

In India, the debate for forming an MPC began in February 2014.

Urjit Patel, the RBI Governor-to-be, was (interestingly enough) the chairman of a Committee that was figuring out the modalities of the MPC. You might wonder why the one who was involved in clipping the Governor’s wings would say yes to the job.

The RBI committee, back then, recommended that this committee should have Five members (three from RBI and two, government-appointed). In 2015, the government recommended that the committee should have seven members (four government-appointed and three, from the RBI). After much haggling and powerplay, they seem to have reached a compromise with equal number of members from both sides.

Rajan also expressed his satisfaction with the suggested composition of the MPC. The Finance Minister mentioned in the Lok Sabha during the Finance Bill 2016 debate that this MPC was formed in consultation with the RBI, so it’s all good.

Or is it?

Earlier, the RBI Governor was given charge of making the right call. He was solely responsible for any bad decisions that he takes and the economy suffers as a result. This also meant that he was that much careful before lowering interest rates or taking any major steps. Now, there’s a committee in place, the responsibility of the decisions taken would be diluted between six people. AKA Collective Responsibility.

Let’s assume a scenario where there is a resolution in place to lower bank interest rates. Three people (government appointees) vote in favour and the other three (RBI appointees including the Governor) vote against. It’s a tie. Now the governor gets a casting vote. Logically, the governor would vote against, keeping in line with his first vote.

But what if he/she decides to vote in favour? What would that exactly mean, in terms of attributing responsibility for making decisions?

Confused? Well, you should BE! These are all questions that need to be asked. The Parliament should have asked them, but oh well. It’s done.

In conclusion, one just hopes Urjit Patel takes all the right calls in the future. So far, the government appointees haven’t been really inspiring.

newslaundry logo

Pay to keep news free

Complaining about the media is easy and often justified. But hey, it’s the model that’s flawed.

You may also like