The Hindu Business Line : Central banking: In search of optimal structure

Describing the structure that lies beneath the policy decision-making of the Reserve Bank of India, A. Vasudevan feels that a monetary policy committee, of the type that exists in the UK, rather than the current Working Group system, may be t he better option though it would need some distinguished persons from outside the RBI.

EVERY AUTHOR would like to see his/her work being critically reviewed and fairly commented upon. Recently, a reader of my book on Central Banking for Emerging Market Economies wrote to me that while the work in his view is one of the best he has seen in recent years, I had not bothered to deal with the centralised versus decentralised structures of central banking.

Besides, my treatment of central banking in relation to India has been described as somewhat apologetic. Finally, he wondered whether I could give my views about the structure that lies underneath the policy decision-making in India's central bank.

I admit that I did not deal with the structure aspect even though there was some reference to it in the report of the working group headed by Mr M. Narasimham on the Transparency of Monetary and Financial Policies as early as September 2000 (see the RBI's Web site). Dissatisfied with the existing decision-making processes, the Group suggested that a monetary policy committee of the type that exists in the UK could be instituted in India too. If this were acted upon, the Committee should include some distinguished persons from outside the RBI.

The existing structure is highly centralised: The Governor takes policy decisions in consultation with the Deputy Governors. But how the decisions have been arrived at is not published. The Deputy Governors representing the Departments within the RBI are expected to know the details of the aspects concerning the decisions being considered.

However, the differences in their backgrounds raise some concerns. Conventions are that one of the Deputy Governors should be an economist, another drawn from within the ranks of the RBI and the third from the world of commercial banking.

The rationale behind this convention is explained thus: An economist would provide the best possible explanations about the conduct of policy and also ensure that the RBI's reports and documents are well written and presented to the public at large.

The person drawn from within the Bank is supposed to be an expert in all or most of the operations of central banking. Deputy Governors drawn from public sector commercial banks are expected to provide insights about the functioning of commercial banks and how bankers view the policy options before the central bank and react to the ultimate policy actions. The Governors, on their part, need not be economists or central bankers: it is enough if they have a robust common sense of political economy. It is difficult to know what exactly is the contribution of each of the Deputy Governors to decision-making. One thing, however, could be stated with a fairly good sense of certainty — the ultimate responsibility of the decision of the Reserve Bank would rest with the Governor. It is expected that the Governor would take the team of Deputy Governors along even if he has not chosen the latter.

Given the need for transparency of good practices, it is important to have a structured framework of decision making with members participating in the process representing the needs of the times rather than the conventions. One can have honest differences of opinion as to what represents the needs of the times but they can be broadly understood to mean high professionalism with a robust sense of new information technologies and management.

Banking and financial services in future would be based on the superstructure of strong information technologies. Traditionally public sector bankers in India have had very little to do with information technology; they spent much of their working lives in regular commercial banking operations such as loan making, accounting and inspections. They also carried with them the philosophy of the public sector that is charitably interpreted as providing public good.

If the public sector banking were to ultimately assume the characteristics of private sector banking, a fact that is widely recognised as the likely future outcome, then one has to hunt not for a traditional banker but for one who views issues of finance in the light of the new technologies and management strategies.

Fortunately, there are many at the top end of research and development in banking and management technology in India. It is, therefore, worthwhile setting up a search committee with members drawn from outside the RBI for getting a right person for the job.

The question of having an insider as Deputy Governor is complex because he/she is said to represent the `culture' and `ethos' of the organisation. But, like Sir Roger de Coverly, one could argue that `much can be said on both the sides'. There is not much evidence to show that the effectiveness of the organisation has improved because of the presence of a Deputy Governor from within. Nor could it be said, again on the basis of evidence, that there would have been greater ineffectiveness of the organisation had there been no Deputy Governor from within.

If there has to be a Deputy Governor from within, the choice of the person should be an informed one, and not based on seniority. Professional competence would mean that the net for head hunting from within should be cast wide. An informal `search' committee could be set up for this purpose as well. In respect of having an economist-Deputy Governor, on the other hand, the present procedures have worked well and could well be persevered with.

The question remains as to why there cannot be a broad-based policy-making body in place of the current one? Mr Narasimham's idea of a committee can be implemented without much ado by asking the Central Board of Directors to elect three persons of the Board who are conversant with not only monetary policy issues but also issues that are related to market efficiency and market stability. The Governor would chair such a committee. In the event of an equal division of opinion, the Governor could cast his vote for either of the two positions under consideration. The proceedings of the meetings should be widely disseminated so that the reputation of the central bank would be enhanced.

This committee, however, would work effectively only if the central bank has the freedom to choose the instruments of policy with no clauses for government overrides. This may require some minor amendments to the Reserve Bank of India Act.

The committee should be independent of the Board of Directors that at present considers a large number of subjects not all of which relate to public policy-making. Dissemination of the Board's deliberations is therefore not the issue. The central bank should provide the policy committee with a team of strong management and strategy thinkers drawn from both within and outside for specific time-periods.

The policy briefs would emanate from such a team. Since the team's briefs bind the committee members to make informed choices among the given policy options, an event that would be closely watched by the markets, the committee system of decision-making would be superior to that of Working Groups whose reports could be ignored by the authorities.

(The author, a former Executive Director of the Reserve Bank of India, can be contacted at asurivasudevan@hotmail.com)