India’s politicians are finding it hard to let go of their central bank

July 31, 2015
Indian Prime Minister Narendra Modi, second right, talks to Bharatiya Janata Party (BJP) president Amit Shah as party leaders Venkaiah Naidu, left and L.K.Advani, right sit beside during the BJP parliamentary party meeting before the start of second day of the monsoon session of parliament, in New Delhi, India, Wednesday, July 22, 2015.

Financial markets sent Indian Prime Minister Narendra Modi’s government a message this week: leave Raghuram Rajan alone.

India’s main stock market fell after the release in New Delhi of a draft proposal that would empower the government to select the majority of members of the Reserve Bank of India’s new monetary policy committee. Modi promised to create a rate-setting panel as part of an overhaul of the way the RBI goes about its work. Inflation was an election issue, and Modi recognized that independent central banks have a stronger track record of containing price increases than those beholden to politicians. Earlier this year, the RBI and the government agreed on an inflation target of 4 percent starting in 2016. (The official aim for this year is to keep consumer price inflation below 6 percent.)

The inflation target was a good sign. The possibility that policy could be set by men and women beholden to the Prime Minister’s Office or the finance minister was a bad one.

Urjit Patel, one of Rajan’s deputies, last year published a report that proposed a five-member policy committee with no role for politicians other than choosing the governor. The draft bill would create a seven-member panel. The government would fill four slots and the RBI three. Terms would last four years and the RBI governor, as chair of the policy committee, would be granted a second vote to break ties.

Moody’s Analytics said that such a committee would undermine the RBI's independence and hurt India's economy. The draft proposals are so out of tune with Modi’s broader vision for economic governance that few are taking them seriously. Bloomberg suggests Rajan will simply let the trial balloon float past. Government officials quickly dismissed the draft legislation as only that —draft. The Financial Times reported that a faction of the finance ministry wanted to remind the RBI who is boss. Rajan remained quiet on the matter. He is set to meet reporters on August 4th after the RBI’s next scheduled policy announcement.

Tension between the fiscal and the monetary authorities is common. So too is jealously. In Canada, the late Jim Flaherty, finance minister from 2006 to 2014, stopped doing joint press conferences with former Bank of Canada Governor Mark Carney, who tended to get all the questions. The Financial Times’s sources suggest Indian Finance Minister Arun Jaitley dislikes standing in Rajan’s shadow. The finance minister rarely shies from making it known that he thinks interest rates should be lower, while Rajan is unique in his willingness to question fiscal and trade policy. It is odd that it is taking so long to set up the monetary policy committee. Jaitley announced the inflation target in his February budget, but set aside governance issues for later. The question shouldn’t be that difficult.

Currently, the RBI operates somewhat like the Bank of Canada, where the statutory power to set interest rates rests with the governor. In the 1990s, Canada’s central bank created a committee of deputies to make policy look less like a one-man show. The governor chooses his or her deputies, with the exception of the senior deputy, whose appointment is approved by cabinet.

But the Bank of Canada is relatively opaque when it comes to policy making. The members of the Governing Council don’t vote and there is no public record of their deliberations. That’s why questions linger about how much influence the Prime Minister’s Office wields over interest rates. On the day of his appointment, Bank of Canada Governor Stephen Poloz was promptly summoned to Prime Minister Stephen Harper’s office to pose for photos. This was unusual. Technically, the prime minister has little to do with the central bank. But the imagery was clear: Harper is in charge. The whispers in Ottawa probably are unfair to Poloz. There would be nothing to gossip about if the members of the Governing Council voted and their votes were released to the public.

A better guide for the Reserve Bank of India’s policy committee is the Bank of England. The government appoints four external members who have votes on interest-rate decisions and the institution counts five. India looks like it could be headed in this direction, which would leave it with a more credible policy-making process than many developed countries. Anything else and the global investing public will know that India’s politicians aren’t yet ready to share the limelight. 

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

About the Author

Kevin Carmichael is a senior fellow at CIGI and the national business columnist at the Financial Post.