Photographer: Dhiraj Singh/Bloomberg

Biggest Indian Central Bank Overhaul to Ease Ties With State

  • New monetary policy panel marks biggest reform in RBI history
  • First test may come as early as Oct. 4, as rate review is due

The biggest change in the Reserve Bank of India’s eight-decade history promises to soothe what was often a fractious relationship between the central bank and government.

Prime Minister Narendra Modi’s administration on Thursday announced three candidates to join an equal number of RBI representatives on a new monetary policy committee, paving the way for India’s first collective interest-rate decision. The move frees the governor from facing the brunt of criticism from the government, which has historically held contradictory demands of lower borrowing costs as well as a tight rein on inflation.

Moreover, since the panel will be guided by an inflation target cemented into law last month, its technocrats in the financial hub of Mumbai will be empowered to stand up to pressure from their bosses in the political capital New Delhi. The MPC’s first test could come as early as Oct. 4, when the central bank is scheduled to next review monetary policy.

"It will set the ball rolling for transparency and continuity in monetary policy making," said Soumya Kanti Ghosh, an economist at State Bank of India, the country’s largest lender. "They will be dictated more by realities on the ground rather than anything else, and if the reality on the ground is any indication, I don’t think the rate should go lower from this level."

Academics Chetan Ghate, Pami Dua and Ravindra Dholakia will be among members who will need to take this decision. They will join RBI Governor Urjit Patel, his deputy in charge of monetary policy, and another central bank executive on the six-member MPC. Each will have a vote with Patel holding an additional tie-breaker, though he won’t be able to veto a majority decision.

For an introduction to each of the MPC members, click here

While Oct. 4 would mark Patel’s first rate review as governor, his predecessor Raghuram Rajan -- who together with Patel had spearheaded the RBI’s overhaul -- was accused by members of Modi’s government of keeping borrowing costs too high. The criticism was despite battling some of Asia’s steepest price pressures.

The previous governor too had similar conflicts with Modi’s predecessor, and at least two of the RBI’s 24 chiefs had resigned due to differences with the government. So, while not much is known about the policy bias of the new MPC members, Modi’s moves to elevate Patel to the top job and ensure that the MPC is free of government employees are therefore "quite sensible," according to Sunil Kumar Sinha, an economist at New Delhi-based India Ratings and Research Pvt., the local unit of Fitch Ratings.

"They are giving a clear signal to the market that the overall decision taken by the MPC will not be driven or guided by the thought process of the government," Sinha said.

Crucial Credibility

Such credibility would be crucial for investors, who’re looking for high-yielding but relatively safe spots to park their funds in a world where several advanced economies have moved to negative interest rates. Dollar-based investors stand to gain 6.8 percent, including interest, on rupee purchases held through the end of 2017, Bloomberg data show. That’s the fifth-highest return among 23 emerging-market currencies, and India is the world’s fastest-growing big economy and carries an investment-grade credit rating.

"What we would be looking at is transparency, predictability of the decisions," Marie Diron, senior vice president and sovereign analyst at Moody’s Investors Service, said in an interview in Mumbai. "I don’t think it’s attached to personalities."

The MPC, however, could take a life of its own in the coming months. Rules stipulate that the central bank must release minutes of each meeting within two weeks, which must disclose how each member voted and why. Too sharp a divergence in views could trigger market volatility.

"There would be greater comfort if there is more unanimity than fragmentation," said Shubhada Rao, an economist at Yes Bank Ltd. in Mumbai.

Smooth Start

Circumstances offer an opportunity for a smooth start. Consumer price-gains eased more than estimated in August after briefly breaching the central bank’s target and most economists in a Bloomberg survey predict a cut in the policy rate to 6.25 percent between October and December from 6.5 percent. Rajan had left it unchanged on Aug. 9 after five reductions.

However, it’s unclear if the MPC will undertake the Oct. 4 review because the monetary authority is mandated to announced a schedule of meetings at least one week before the first one. For now, the creation of the panel marks a step toward long-awaited structural changes at the Reserve Bank, Shilan Shah, a Singapore-based economist at Capital Economics Ltd., wrote in a report on Thursday.

"The announcement should put to bed lingering investor concerns that the government is attempting to erode the independence of the central bank," he said.

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