FSLRC report: Will financial sector really benefit from it?

The Financial Sector Legislative Reforms Commission (FSLRC) which was set up to rewrite and update all the archaic Indian financial sector laws, has recommended vast changes to the Reserve Bank of India's role.

The committee recommends any policy to be made not just by the RBI Governor but by a council comprising Governor and Deputy Governor from RBI and five more external members appointed by the Government. The second recommendation is that the government in consultation with the Governor, will give the central bank quantifiable monitorable objectives; the RBI will need to state reasons why it has failed to achieve the objectives and what remedial action it will take to achieve the objectives. The committee has also recommended that the government and not the RBI will make rules with respect to capital inflows. This recommendation is irrespectiove of whether the inflows are fdi, fii, forex loans or nri deposits. The last recommendation is that the RBI will also be the banking regulators but it won’t have any control over non bank finance companies (NBFCs). Many of these proposals impacting the RBI's powers were opposed by three dissenting members of the FSLRC: P J Nayak, Y H Malegam and K J Udeshi.

Subir Gokarn, former Reserve Bank of India (RBI) Deputy Governor gave his views on the FSLRC's recommendations in an interview to CNBC-TV18.

Below is the edited transcript of Gokarn's interview.

Q: At the moment the finance ministry makes rules with respect to foreign direct investment (FDI), but rules with respect to foreign institutional investors (FII), external commercial borrowings (ECBs), forex loans as well as non-resident Indians (NRI) inflows are made by the Reserve Bank of India (RBI). Given the perilous nature of the current account deficit (CAD) at this point in time, do you think this is a wise decision to take away these powers from the central bank? A: We shouldn't be categorising these into black or white. I haven’t had a chance to read the report nor the dissenting notes that came, so I can’t really comment on the specifics. However, I think we have to take a sort of strategic and system wide view of what works best. It is perhaps a little premature to look at this as a complete break or a complete change in the framework. So, let me not comment on the specifics because I need to study them a little more carefully. Q: There are a couple of more things which the Financial Sector Legislative Reforms Commission (FSLRC) has recommended broadly on which your comments would be welcome. First and foremost the FSLRC has said that monetary policy should be made by a committee. That committee of seven members would have two members from the RBI, presumably the governor and the deputy governor incharge of monetary policy and the remaining five appointed by the government. Do you think we are in a situation where this kind of an experiment will succeed; has the time come for kind of a counselor approach? A: The objective of distributing responsibility for making the monetary policy decision is legitimate. I don’t have any problems with the objective which is to take the onus of the judgement away from one individual and spread it across a structure – a formal collective process. How it has to be structured is a question that raises several questions. So, who are these people? Will they be employees of the RBI or employees of the government?  What does that mean for their loyalties? Are they independent even though they have contractual arrangements with either RBI or the finance ministry or some other entity?

These are the sort of nitty grities that can make or break this arrangement because ultimately, this arrangement depends entirely on the perception of autonomy and independence. If that committee is not perceived to be autonomous or independent, the entire credibility of monetary policy becomes suspect. So, while the objective is perfectly legitimate, a lot of thought and lot of care has to go into designing the structure and giving it these attributes, ensuring that these attributes are not compromised on. Q: The model code put out by the FSLRC also says that the central bank would be given targets by the government possibly in consultation. Those targets would be the failure standards by which the central bank will be measured. Are we really in that situation in terms of the central bank being able to deliver the kind of targets set by the government or should we worry that elsewhere in the world people have moved away from such target settings? A: The broad perspective on explicit targets and accountability based on those targets can make sense as a concept, but what are these targets? Is there flexibility or autonomy or discretion to assign different kinds of weights to different targets in different circumstances? These details and operating practices will have to be fleshed out. So, the challenge here is, even if one accepts the general principle of the recommendations, the challenge will be to translate them into effective, credible structures and operating practices. So, that's where we have to focus on. If we accept that a particular objective is legitimate, how do we actually put it into play, how do we put it into practice? The collective responsibility makes sense, there may be multiple targets and one will have to then allow some discretion in terms of which one is most important in any given situation. The concern is the autonomy, the perception of autonomy and independence of the collective group, however it is constructed. Q: Is it practically possible for the central bank to deliver on an inflation or a growth target in an Indian situation where so many of the cards are held by the government? Will the Reserve Bank of India (RBI) be able to deliver on targets? A: A contract is two-sided. It is important not to take this in black and white terms. We are talking about 50 or 60 legislative reforms that the commission has recommended. The fundamental question is- do all of them need to be done in order to achieve the final outcomes that are being sought? Or can it be done one at a time, based on opportunities and if so, is there a particular sequence in which they need to be done. So, these are important analytical questions which the debate on the recommendations needs to focus on.