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By Mihir Sharma
In the very near future, we will learn the identities of three new 'external' members of the Reserve Bank of India’s six-person monetary policy committee. The system is relatively new. The government must use this opportunity to strengthen, not weaken it.
The very existence of a monetary policy committee is one of Prime Minister Narendra Modi’s most important achievements. In the decade Modi has held power in New Delhi, he has generally avoided institutional improvements or reform, focusing instead on transitory targets and project management.
But, early on, his government passed legislation setting an inflation target of 4 per cent for the RBI. It devolved responsibility for meeting that target to a committee in which half of the members would come from the central bank and three would be external nominees.
In the years since, India has achieved a level of macroeconomic stability unusual in its history and exceptional for a developing country. Modi’s officials often pat themselves on the back for transforming India’s economy from when it was numbered among the “fragile five” most exposed to the 2013 'taper tantrum'. While it helps that the finance ministry has been careful not to overspend, the credibility of a genuinely independent central bank has played an even greater role in that success.
The bank’s performance has boosted Modi’s political fortunes. His repeated electoral successes owe much to the fact that consumer price inflation — a perennial problem in India prior to 2016 — has largely been controlled ever since a formal target was set and the RBI freed to pursue it.
Like voters elsewhere, Indians can forgive stagnant growth, high unemployment, and even massive disruptions such as Modi’s decision to eliminate 86 per cent of the country’s currency overnight. What they can’t abide is persistently high inflation.
It’s essential that the government remember these lessons now. The process of appointing new members to the committee has only occurred once, and so far most of the external members, who serve four-year terms, have been well-respected academics rather than time-serving nobodies or ideological fellow-travelers of the ruling party.
Not surprisingly, officials in New Delhi have dropped loud hints that they would prefer that the RBI do more to support their efforts to boost growth. Politicians always think rates are too high.
The finance minister last year was critical of what she called an “obsession” with using rates to control inflation, warning that “central banks will have to keep in mind growth and growth-related priorities.” Modi himself repeated that advice earlier this year.
Such statements ought to be read as signals, not instructions. The risk is that the government could appoint new committee members who would view them as commands.
Past conflicts between the RBI and Modi’s administrations provide some worrying context. In 2018, the two disagreed strongly on what should be done with the RBI’s reserves. The bank’s senior management wanted to hang on to them; New Delhi wanted to use them to prop up the federal budget.
After a spate of resignations and the appointment of a new governor, frictions eased. This year, the RBI’s dividend to the government was the highest in history, 150% above the previous year. That transfer, equivalent to about 0.6% of GDP, allowed the government to meet its fiscal deficit targets for the year.
The markets can overlook such generosity since what the RBI does with its reserves wasn’t part of the core of independence it was promised in 2016. Rate-setting is.
The policy committee is unique in some ways because technocrats and other experts have otherwise largely been frozen out of governance under Modi. His administration appears to have little patience for them; it distrusts even independent regulators and has evinced undisguised contempt for academics.
Modi’s lieutenants prefer to appoint people they know are committed to their political aims. Charitably, you might argue that the government believes a unity of purpose across the Indian state is more important than regulatory independence or expertise. Critics might note that mediocre time-servers tend to be unthreatening and obedient.
It would be particularly dangerous to submit to these impulses when staffing the RBI’s committee. The bank’s credibility, India’s macroeconomic stability, and Modi’s own popularity depend upon monetary policy remaining independent.
Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.