Monetary Policy : Institutional Framework and Implementation Procedure in India

GRIPS, TOKYO 18-JULY-2014

Policy Design and Implementation in Developing Countries Ratul Rana

A central bank’s success depends on the quality of its decisions

Even with a clear target, suitable instruments and full insulation from outside

pressures, a central bank cannot possibly foresee all contingencies

Decision has to depend on judgment and, therefore, some discretion, which

is best bounded by credible and transparent institutional accountability, is unavoidable

“The Quiet Revolution : Central Banking Goes Modern” (Alan Blinder, 2004) Governor as the single decision-maker is being replaced by committees and no country has yet replaced a committee with a single decision-maker.

INTRODUCTION

COSTS

free riding (what psychologists call “social

loafing”—letting someone else do the work)

inertia (could be easily embedded in decisions tending to status quo even as a default option)

Groupthink (the psychological drive for consensus)

BENEFITS

gathering more and better information

Pooling different conclusions, potentially reducing errors

insurance against strong individual preferences

peer reviews promoting openness of interaction and independence.

Committee Approach

INTERNATIONAL EXPERIENCE

Board of Governors of the Fed is responsible for the discount rate and reserve requirements

Federal Open Market Committee (FOMC) is responsible for announcing the Fed Funds target rate

Monetary policy is decided by the Policy Board at Monetary Policy Meetings

Monetary Policy Committee is a consultative body, which has an advisory role in the context of comprehensive research on the macroeconomic situation State Council, which is also entrusted with the monetary policy

decision, sets the Macro targets

The International Experience

Number of members on Policy Making Committee

External Members?

Meetings per year

Governor's term (years)

Decision Making Process

Votes Published

Armenia 7 No 12 6 Vote No

Australia 9 6 11 7 Consensus n/a

Brazil 8 No 8

No fixed term Vote Balance of Votes

Canada 6 No 8 7 Consensus n/a

Chile 5 No 12 5 Vote Yes

Colombia 7 No 12 4 Vote Majority or Unanimous

Czech Republic 7 No 8 6 Vote Yes

Ghana 7 2 6 4 Consensus n/a

Guatemala 8 7 8 4 Vote No

Hungary 5 to 9 4 12 6 Vote Yes

Iceland 5 2 8 5

Consensus otherwise

vote Balance of Votes

Indonesia 6 to 9 No 12 5 Consensus n/a

Israel 6 3 12 5 Vote Balance of Votes

The International Experience

Source: Central bank websites

Number of members on Policy Making Committee

External Members?

Meetings per year

Governor's term (years)

Decision Making Process

Votes Published

Mexico 5 No 8 6 Consensus n/a

New Zealand Governor n/a 8 5

Governor decides n/a

Norway 7 5 6 6 Consensus n/a

Peru 7 No 12 Term of

Parliament Vote No

Philippines 7 No 8 6 Vote No

Poland 10 9 12 6 Vote Yes in Inflation Report

Romania 9 5 8 5 Vote No

Serbia 5 No 12 6 Vote No

South Africa 7 No 6 5 Consensus n/a

South Korea 7 5 12 4 Vote No

Sweden 6 No 6 6 Vote Yes

Thailand 7 4 8 5 Vote Balance of Votes

Turkey 7 1 12 5 Vote No

United Kingdom 9 4 12 5 Vote Yes

The International Experience

Source: Central bank websites

4

1

3

1

4 7

7

0

1

2

3

4

5

6

7

8

9

10

Consensus Governordecides

Majority Vote(Published)

Majority Vote(Note

Published)

Industrialized Countries Emerging Market

8

1 18

Consensus Governor decides Majority Vote

The International Experience

Source: Central bank websites

MONETARY POLICY DECISION MAKING IN INDIA

MONETARY POLICY DECISION MAKING IN INDIA

The responsibility, accountability and timing of decision-making relating to monetary policy remains with the GOVERNOR who is directly accountable to Government of India

Monetary policy decisions are made by the Governor alone

Monetary policy formulation in the RBI has been traditionally internal

MONETARY POLICY DECISION MAKING IN INDIA

Central Board of Directors

MONETARY POLICY DECISION MAKING IN INDIA

Appointed/nominated for a period of four years Constitution:

Official Directors Full-time : Governor and not more than four Deputy Governors

Non-Official Directors

Nominated by Government: ten Directors from various fields and two government Officials Others: four Directors - one each from local boards

Central Board of Directors

MONETARY POLICY DECISION MAKING IN INDIA

In 2005, a Technical Advisory Committee on Monetary Policy (TACMP) was setup

External experts in the areas of monetary economics, central banking, financial markets and public finance

Committee is chaired by the Governor, with Dy. Governor in charge of monetary policy as the vice-chairman and other Deputy Governors as internal members

meets at least once in a quarter, reviews macroeconomic and monetary developments and advises the RBI on the appropriate stance of monetary policy

Mid-quarter reviews were introduced in 2010

Points of discussions of the TACMP are placed in the public domain, with a lag of roughly four weeks after the meeting of the Committee (Jan, 2011)

MONETARY POLICY DECISION MAKING IN INDIA

October 2005 : Pre-policy consultation meetings with representatives of different segments of the banking sector, trade and industry bodies, financial market participants, credit rating agencies and other institutions

2009 : Consultations with senior economists and market analysts twice a

year in the run up to the annual policy and the second quarter review

Close to the policy decision, an established practice for the Governor is to meet the Prime Minister and the Finance Minister informally, give them an assessment of the macroeconomic situation and indicate to them his proposed policy stance.

Transparency in the process of policy formation ? RBI places in public domain all data/inputs that go into the formulation of monetary policy – its internal macroeconomic assessment and results of surveys in the form of a report entitled ‘Macroeconomic and Monetary Developments’

MONETARY POLICY DECISION MAKING IN INDIA

Central Board of Directors

Technical Advisory Committee on

Monetary Policy

Pre-policy consultations

MONETARY POLICY DECISION MAKING IN INDIA

LEADER (GOVERNOR) plays a KEY ROLE in the current setup

THE ISSUE OF ACCOUNTABILITY

ACCOUNTABILITY

Central bank accountability is the mechanism through which a system of checks and balances is established for the central bank in a democratic setup

Formally, central banks are accountable to the Government or the Parliament, from where they derive their statutory authority

In practice, they are typically made accountable to legislative committees, ministers of finance, or supervisory boards

Mechanisms through which central banks are held accountable : (i) monitoring by the government or legislature, (ii) publication of regular central bank reports, (iii) tacit endorsement (the government or Parliament in about one-fifth of

countries has explicit power to provide formal directives to the central bank, to override decisions or otherwise change the course of policy)

ACCOUNTABILITY : RBI

The RBI Act,1934 does not prescribe any formal mechanism for accountability

Governor holds regular media conference after every quarterly policy review which is an open house for questions, not just related to monetary policy, but the entire domain of activities

RBI also assists the Finance Minister in answering Parliament questions relating to its domain

Governor appears before the Parliament’s Standing Committee on Finance whenever summoned, which happens on an average three to four times a year

India’s financial regulatory architecture dates back to the 1930s

Financial Sector Legislative Reform Commission (FSLRC) setup in 2011 to propose reform of financial sector legislation

The Commission submitted its report in March 2013 *

Recommendation : Independence needs to be accompanied by legal and administrative processes that clearly delineate the functioning of the regulator from the rest of the Government

ACCOUNTABILITY : RBI

“ The Reserve Bank of India is a statutory corporation constituted by the Act of 1934, which is wholly under the control of the Government of India....”

* http://finmin.nic.in/fslrc/fslrc_report_vol1.pdf

ACCOUNTABILITY : RBI

Proposed parameters of accountability proposed by FSLRC (a) write a document explaining the reasons for these failures (b) propose a programme of action (c) demonstrate how this programme addresses the problems that have hindered the achievement of the target(s) and (d) specify a time horizon over which the targets are to be achieved.

THE ROAD AHEAD…

The ROAD AHEAD…Formal MPC ??

Several committees have recommended formation of a full-fledged MPC

- The Standing Committee on International Standards and Codes, 2002 (Chairman: Dr. Y.V. Reddy)

- The Committee on Fuller Capital Account Convertibility, 2006 (Chairman: Shri S.S. Tarapore)

- The Committee on Financial Sector Reforms, 2009 (Chairman: Dr. Raghuram G. Rajan)

- The Committee on Financial Sector Assessment, 2009 (Chairman: Dr. Rakesh Mohan)

- The FSLRC, 2013 (Chairman: Shri B. N.Srikrishna)

THANK YOU