India government panel rattles market with plan to clip RBI wings

(Reuters) – Proposals from an Indian government panel reviewing monetary policy rattled markets on Friday, as foreign and domestic traders said a move to increase the government’s weight in decision-making could undermine the central bank’s independence.

Under the panel’s latest proposals, published late on Thursday and part of a broad and lengthy financial overhaul, the government would appoint four out of seven positions on a planned monetary policy committee.

The Reserve Bank of India would appoint three – one more than under earlier plans, but still less than the government.

Under the proposal, the RBI governor also has no veto power, though he did under an earlier iteration of the plan.

"The government appointing the majority of the external members in the monetary policy committee will dilute the independence of the RBI," said Rupa Rege Nitsure, chief economist at L&T Finance Holdings, who worked on a central bank report on monetary policy published in 2014.

"In a political economy set up, it is difficult to have intellectual independence."

Traders said they worried that if the proposed changes were implemented it could hurt the RBI’s ability to push ahead with policies like inflation targeting, which has helped contain endemic price rises.

"After buying into India given the way RBI has managed inflation, forex market, foreign investors will be worried about the credibility of the decision-making process if the government has a bigger say than the RBI," one foreign bank trader said.

Government officials directly involved with the drafting process, however, played down market concerns. They said the draft was not final, and the RBI would respond in time.

The proposals, from India’s Financial Sector Legislative Commission (FSLRC), are a revised version of a previous report that was published in 2013.

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RBI Governor Raghuram Rajan said that report was "schizophrenic", and would turn the RBI into a "paper tiger".

The RBI targets consumer price index inflation at 6 percent by January 2016 and 4 percent by March 2018. Sticky retail prices and concerns over an inadequate monsoon have kept the central bank cautious, even as the government badly needs lower rates to accelerate economic growth.

The RBI has cut interest rates by 75 basis points this year.

"There has been no formal discussion with the RBI on this report," said the government official. "The RBI will be formally consulted when we start drafting the bill."  (New Delhi/July24/2014)

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