Financial stability | RBI must reorient its goals and communication

One was startled to note that the MPC did not discuss the most troublesome issues facing Indian economy. Even the minutes of the policy review meeting showed that there was no discussion on the failure of PMC Bank.

I am sure there was discussion, but it was off the record, given that the meeting was about the monetary policy. It is also amazing how far the RBI has come when it comes to monetary policy decisions and discussions -- both within and with the media.

The mind goes back to the pre-MPC era when we had similar monetary policy meetings, but media interactions went beyond just interest rate discussions. At that point, the responsibility of interest rate decisions lay with the Governor. During the media interactions, the Governor along with Deputy Governors (DGs), not just explained the rationale behind the decision, but also took questions around broader economic developments, including matters pertaining to the banking and financial sector. There was a reason that these meetings were called monetary and credit policy and not just monetary policy. In fact, many continued to call it just the credit policy, which was reflective of the pre-1991 era when the RBI determined not just credit flow but also interest rates set by banks.

In the post-inflation targeting era which started from 2015 onwards, all this has changed. The top bank has been a given an inflation target of 4 per cent with a band of +/- 2 per cent. The monetary policy decision has devolved to a six-member MPC that includes three representatives from the RBI, including the Governor and one Deputy Governor, and three external members appointed by the government.

The MPC reviews the economic conditions and accordingly votes on the policy interest rate required to achieve the inflation target. The RBI says it follows flexible inflation targeting, which means it pays attention to growth as well. However, the priority lies with inflation.

It has been nearly five years since the RBI adopted inflation-targeting and three years since the MPC was instituted. During this time, a lot has changed in the economy, especially in terms of inflation. For a long time, high inflation had been the bane of Indian economy. India was one of the outliers in a post-2008 world with concerns over price stability, but not much on the financial stability front.

However, in very quick time, high inflation has ceased to be a worry as inflation has been below the targeted 4 per cent for most part of this year.  So much so, analysts claim that this low inflation has become a bane for farmers and the rural economy!

Price stability is not as much of a concern in today’s world. With recent events, India has joined rest of the world with few concerns on price stability and heightened concerns on financial stability (see the earlier piece). For an observer and student of Indian economy and financial markets, it is quite surreal to witness the recent reversal of fortunes.

From 2008 onwards, other central banks have strengthened financial stability in a big way. The US Federal Reserve has two Vice-Chairs, one responsible for monetary stability and other for supervision. The Bank of England (BoE) has instituted a separate Financial Policy committee and the European Central Bank has been given additional responsibilities for banking supervision. These different financial bodies within the central bank then go on to present their various reports/analysis and communicate to media/people.

However, in RBI’s case, first, the monetary policy meetings have been narrowed to just interest rate decisions. Second, this narrowness has meant that other critical matters are not given due importance. It was puzzling how questions pertaining to demonetisation never became the central agenda for MPC meetings. Third, half of the MPC team, which makes these decisions, is never part of media discussions. Ideally, the entire MPC should answer media questions, but even today it is just the Governor and the Deputy Governors. The three external MPC members (external) are not part of the media discussion and never deal with the media. Other central banks such as the BoE even publish speeches of external MPC members on the central bank’s website.

The RBI issues reports and publications (Financial Stability Report, Trend and Progress of Banking in India) and now needs a proper forum/structure to communicate the findings to the media.  One way is to include the financial discussions part of the MPC, but that would weaken the rate-setting body. The RBI should instead take a leaf from other central banks and develop a separate forum for financial markets.

The banking watchdog should first reorganise its top management and allocate all matters pertaining to financial markets to one Deputy Governor, who reports the matters to the Governor. Currently, the RBI allocates sector such as Banks, NBFCs, Co-operatives and the like across different DGs and same is the case with functions such as regulation, supervision and inspection across different DGs. All these have to be organised under one DG who should be accountable and answerable for financial stability.

The responsibilities have become more complex after Viral Acharya’s departure. The RBI has three DGs and Acharya’s earlier responsibilities (monetary policy and research) have been allotted to the three remaining DGs. The central bank not only needs a fourth Deputy Governor urgently, but also reallocate tasks under proper heads.

Once we have fixed this responsibility, the idea is to make this one position accountable for all publications and communicating with media or people. Say, after release of the Financial Stability report (FSR), the Deputy Governor in-charge should explain the key findings and developments, along with the Governor.

These changes will go some way in resolving the more pressing problems of building a financial system to protect the savings of the public (That requires a separate piece to elaborate!)  They will also streamline the functions of the RBI towards the twin long-term goals of price stability and financial stability and build accountability in the system.

(Amol Agrawal is faculty at Ahmedabad University. Views are personal.)