Setting Policy Rate in Line With Global Practices, The Way Forward

Published: 02nd August 2015 06:05 AM  |   Last Updated: 02nd August 2015 06:05 AM   |  A+A-

The newspapers are replete with headlines about the Indian Financial Code (IFC) and the ‘dilution’ of RBI powers. This article is an attempt to look at the overall framework of IFC, the rationale and in this context look through the specific issue of power dilution or otherwise.

As we all know we have a deep legal system with some laws dating over 100 years and made in a different context and more so by an imperial power. It is critical that we review, abolish and/or modify these to be in line with current thinking. The Jain Commission, set up in 1998, estimated that there might be 25,000-30,000 state laws. Of administrative and local laws, they simply could not calculate. It was under Arun Jaitley as the Union Minister of Law in 2000-2002, that 200 obsolete laws were finally repealed.

The Government wants to simplify archaic laws and PM Narendra Modi, before taking oath as PM said, “Give me 10 laws each in your department which we can repeal.” According to the PM’s Office, there are 1,382 archaic laws that need to be repealed.

Union Law Minister Ravi Shankar Prasad introduced the Repealing and Amending Bill, 2014, in Parliament this month. “I will ensure that in the next session of Parliament, up to 300 outdated laws are repealed,” he said.

The UPA regime had set up the FSLRC under Justice B N Srikrishna to review and simplify over 60 laws governing the financial sector. As pointed out by Bibek Debroy, the preamble to the Act governing the RBI confers on India’s central bank a temporary status that continues even now.

Why is there special emphasis on the financial sector? Other than the usual statement of money makes the world go around, there is a strong economic rationale and nexus between growth of the finance sector and the economy.

An ADB paper on financial sector development found that increasing the financial depth (measured by the ratio of liquid liabilities to GDP) from the mean of the slowest growing quartile of countries to the mean of the fastest growing quartile of countries would increase a country’s per capita income growth rate by almost one percentage point per year. Given that the difference in average annual growth rate between these two sets of countries is about 5 percentage points over this 30-year period, differences in the depth of the financial sector alone explain about 20% of the growth difference.

It quotes that economists believe that the most important role of the financial sector in facilitating growth is to reduce information, enforcement, and transaction costs. The same article identifies five key functions like mobilising savings, monitoring investment, facilitating trading etc. Through these functions, financial sector development facilitates economic growth. The issue is how to develop a financial system that facilitates and supports economic growth in the context of financial stability.

The FSLRC has a similar framework but a broader remit and looks at the following as tasks - consumer protection, micro prudential regulation, resolution, capital controls, systemic risk, development and redistribution, monetary policy, public debt management, contracts, trading and market abuse.

The FSLRC report is exhaustive and the commission thinks it is better to have non-sector laws that are prudent compared to the present sectoral laws and advocates principle-based laws.

Harish.jpgHaving a strong independent regulatory system is key and FSLRC has developed a framework for regulators involving a single framework for governance across all regulators rather than developing specific ones. This brings consistency and regulator accountability.

It is in this framework that the current headlines on Governor’s power dilution need to be examined. The FSLRC has recommended setting up a Monetary Policy Committee (MPC), comprising of chairperson (Governor), one executive member of the board, plus five persons nominated by the government, two in consultation with the chairperson. The government can also nominate an observer. The governor can overrule the committee’s recommendations, which otherwise should be based on consensus or majority and the voting details must be made public. In case of a tie, the Governor has the casting vote. 

This is in line with international practices where the policy rate is set by a committee rather than one person, is independent and the votes and suggestions are disclosed. In the US, a 12-member group takes decisions by consensus. In the UK, the 9-member committee decides based on a majority with each member carrying one vote.

What can be done to make this effective?

■ As a democratic country, it is better to have a collective decision than an individual no matter how brilliant or competent

■ A committee is better placed to withstand political pressure particularly prior to an election

■ None of the members should be government employees or be involved in political activity and should have no conflict of interest with their position. The worries are that these positions would be taken by retired bureaucrats and hence subject to traditional pulls and pressures. A suggestion could be to exclude retired bureaucrats

■ Government nominee as an observer which adds to the pressure could be dispensed with

■ The recommendation of providing for judicial review needs to be reconsidered. Having judicial review means decisions can be questioned and makes for risk averseness than decision-making. The only area that judicial review may be appropriate is if there is conflict of interest and even here safeguards to avoid needless dragging of MPC members to court must exist

■ The term of the MPC is 4 years which needs to be considered and probably needs to be much longer

The ‘apparent’ dilution of powers are clearly there but this is a robust structure which builds in an institutional framework, reduces government’s ability to influence one individual, dilutes ability of one person on key decisions, forces debate and increases accountability.

There are several useful aspects in the code. For instance, it is critical to have a good framework aiding economic growth and prevent the common man, who is regularly subject to financial frauds. The other key aspect is enforcing contracts which is critical to improve our ease of doing business. Currently, we are ranked 186 out of 189 countries.

I’d recommend we look through the lFC from an overall perspective and ensure it is implemented after due deliberation by Parliament and the work is extended to other areas of law which also require reform.

(The writer is Partner - India Leadership Team, Grant Thornton India and the views expressed here are personal and based on the report of the Commission and other public sources)

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