Government of India Volume I: Analysis and Recommendations

MONETARY POLICY
The staff of the central bank report to the head of the central bank and face obvious
conflicts of interest in voting independently. Additionally, having multiple members from
one organisation raises the possibility of group-think. These concerns are addressed by
having five external members on the MPC. However, ultimately it is the head of the central
bank who must be held responsible for delivering on the monetary policy objectives.
The accountability mechanisms (described ahead) would ultimately rest with the
head of the central bank. Hence, under extreme circumstances, the head of the central
bank has the power to override the MPC. However, this would have to be accompanied
by a letter to the Central Government, which would be released into the public domain,
explaining why he/she feels that the MPC is exceptionally incorrect in its assessment, thus
justifying an exceptional bypassing of the MPC.
Under normal conditions, monetary policy can generally be conducted using only
one instrument, the control of the short-term policy rate. Occasionally, there may be a
need to use other instruments, such as ‘quantitative easing’, or, trading on the currency
market, or, capital controls. 1 The framework envisaged by the Commission is unified in
its approach: All powers of monetary policy should be wielded in the pursuit of well defined
objectives established by the Central Government, and all exercise of these powers
should be done by voting at the MPC.
The structure and functioning of the MPC is summarised in Table 11.2.
11.5. Accountability
Alongside the definition of the monetary policy objectives of the central bank, the Statement
of the Central Government that establishes the objective of monetary policy would
clearly define what constitutes a substantial failure to achieve monetary policy objectives.
If such an event should arise, the head of the central bank would have to: (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 MPC expects
the target to be achieved.
A further check is envisaged in the form of a reserve power granted to the Central
Government to issue directions to the central bank on issues of monetary policy under
certain extreme circumstances. Given the drastic nature of this power, any direction under
this power must be approved by both Houses of Parliament and can be in force only
for a period of three months. Such direction may be issued in consultation with the head
of the central bank.
11.6. Institutional structure
11.6.1. Board of the central bank
The board of the central bank would oversee the functioning of: (a) monetary policy; (b)
micro-prudential and consumer protection functions for banking; and (c) micro-prudential
and consumer protection functions for payments. The Chairperson and the board
would ultimately be responsible for continually reforming the organisation so as to deliver
on its objectives as defined in the draft Code. Decision-making about organisational
and institutional arrangements would take place at the board.
1 The Commission envisages that the central bank will frame regulations on outbound capital flows, in consulta-
tion with the Government.
FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION 107