Urjit Patel Committee Monetary Policy Reform - Accountability

7/29/2014 Urjit Patel Committee Monetary Policy Reform: Accountability
http://mrunal.org/2014/02/economy-urjit-patel-committee-fixing-accountability-in-rbi-monetary-policy-committee-decision-by-majority-fiscal-deficit-part-2-of 1/14
[Economy] Urjit Patel Committee: Fixing Accountability in RBI, Monetary Policy Committee,
Decision by Majority, Fiscal Deficit (Part 2 of 2)
CSAT

1. Prologue
2. #2: @RBI fix accountability in
monetary policy making
3. Monetary Policy Committee
1. MPC Decision by Majority
2. MPC: Accountability for
#EPICFails
3. MPC: Summary
4. #3: @Government give Cover fire to RBI
1. #: MNREGA:
2. #: MSP
3. #: Fiscal Deficit
4. #: Loan Waiver
5. Urjit Patel: Misc recommendations
6. Mock Questions
Prologue
RBI had formed a Committee under Dy. Governor Urjit Patel to strengthen monetary policy
framework. Committee gave three major recommendations:
1. @RBI Target inflation (4% CPI; 2% band). Already covered in previous article click me.
2. @RBI fix accountability (discussed in this article)
3. @Government: help RBI fight inflation (in this article)
#2: @RBI fix accountability in monetary policy making
What is the existing mechanism in RBI?
1. Governor: Selection by finance minister, approval by Prime minister, appointment by
Government of India.
2. Term: three years for Rajan.
3. Eligible for re-appointment? Yes RBI Act provides for appointment of a governor for a period of
up to five years.
4. He is directly accountable to government of India.
5. Government can even issue him directives in public interest.
6. Rajan is also accountable to Parliaments standing Committee on Finance. They can summon
him. On and average, RBI governor has to appear before this Committee 3-4 times a year.

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What's New? ?
How is monetary policy formed right now?
At present, monetary policy is made by the governor alone.
Rajan does consult with his Dy. Governors, board of directors etc. but only Rajans signature
necessary for approval file= meaning Rajan and Rajan only is the decision maker.
Some initiatives in recent times:
2005: RBI governor started consulation meeting with noted economists, industrial bodies
(FICCI etc) and Credit Rating Agencies (CRISIL etc.)
RBIs annual reports put on the official website
Governor publishes quarterly reviews, and during the release, he answers media queries.
But overall, Monetary policy is still one man game, without any formal mechanism for ensuring
participation and accountability.
Recommendations in Past:
Previous Committees Tarapore, Reddy, FSLRC etc. have directly/indirectly recommended that
1. Monetary policy should be decided by a Committee
2. Decision based on majority voting
3. Publish minutes of such meetings on the website/media.
Mohan alright man now come to the point.
Urjit
Well, Considering all of above facts and factors, I
recommend that RBI should form a monetary policy
Committee.
Monetary Policy Committee
Total five people in this Committee:
1. Chairman: Rajan himself (governor)
2. Vice Chairman: Any one Dy Governor (RBI has total four governors)
3. Members:
1. One Insider: RBIs own Executive Director (in charge of Monetary policy).
2. Two outsiders/External members:
Noted Economists, finance experts etc, whore not office bearers in RBI.
term: three years
not eligible for re-appointment.
Outsiders: Safeguards and provisions
The outsider members will have the right to assess all
Urjit data/files/records in RBI office.But he cannot hold office
of profit under the government.
Mohan Meaning?
Urjit
To put this in crude words: he should not be on the
payroll of the government. for example: IAS officers,
bureaucrats, even certain bodies / corporations funded
by the government.
Mohan But why?
Urjit
Government may try to influence RBIs decision making
via such member- because his bread n butter depends
on that job.
In all the advanced economies, monetary policy is made by a Committee of independent
members- even in China, government directly doesnt interfere with its officers/representatives.
Exceptions where government side is represented in Monetary policy Committee =Colombia,
Philippines.
Conflict of Interest
Urjit
Secondly, such outside member must not involve in any
activity that has conflict of interest with RBI.
Mohan Meaning?
Urjit
Consider HSBC, Morgant Stanley, JP Morgan
Chase etc giants. They have license to operate as
Primary dealers in India. Meaning they can directly
buy and sell government securities. So, if monetary
policy Committee member also provides
consultancy services to such firms= there is conflict
of interest.
What if he leaks information to that company, e.g.
RBI will start Open market Operation in week OR
RBI is set to decide Repo rate @xx%.
Those primary dealers could make windfall profits
from such insider tips.
MPC Decision by Majority
Urjit
Monetary Policy Committee (MPC) will decide the
monetary policy by voting among themselves.
Mohan But what if there is a tie?
Urjit
Noone will be allowed to abstain from the voting.
(unlike the CBI fearing parties in Rajya Sabha).
All five members must vote on each and every issue
brought on table.
Since 5 is an odd number, there is no chance of
tie.
Mohan
Ya but what if one member is absent? Then four
members left= 2 vs 2 tie possible!
Urjit
In that case Rajan (Chairman) will give the casting vote
to break the tie.
Mohan
But what if Rajan himself is absent? And there is 2vs2
tie?
Urjit
Then Vice Chairman of the Committee (Dy.Governor)
will give the casting vote to break the tie.
Mohan But what if He is also absent?
Urjit
if both chairman and VC are absent, then common
sense suggests we should postpone the meeting!
Mohan
Ok one last doubt: you told there are five people in MPC
Committee: three insiders (Rajan, Dy Governor and one
member) vs two outsiders (external members).
What if one of the outsider member always gives
dissenting vote.Ultimately, Rajan bhais goonda-
log beats him to pulp to make sure he remains
absent in the meeting.
and then Rajan bhai uses his own casting vote to
decide policy according to his own whims and
fancies!
How will you maintain accountability in that case?
Solve it for [Ethics] GS4.
Im not going to dignify that stupid question/case study
Urjit with an answer. Lets move to next topic:
MPC: Accountability for #EPICFails
In the previous article we saw the Target: RBI must control CPI within 2-6% range. (i.e. 4%
CPI with +/-2% band)
EPICFAIL = When MPC fails to keep CPI within this range for three successive quarters.
(meaning 3 x 3 = 9 months continuously CPI remains outside the [2,6] range.)
In case of such #EPICFAILs, Urjit Patel recommends
1. MPC Must issue a public statement
2. Every MPC member must sign it
3. This statement will contain
1. Why did we fail? (Reasons)
2. How will we fix it (Future action proposed)
3. By when will we fix it? (Timeframe)
MPC: Summary
STRUCTURE
Total five persons.
1. RBI governor as chairman
2. RBI dy.governor as Vice chairman
Members:
One Executive director of RBI
Two members from outside RBI.
cannot hold office of profit,
cannot involve in work that has
conflict of interest with RBI
term: three years
not eligible for re-appointment.
DECISION
MAKING
Must meet once every two months.
Decision by majority voting
Each person has one vote.
Member cannot abstain from voting.
If there is tie, Casting vote power to
Governor and Dy.Governor.
TRANSPARENCY
Must publish minutes of the meeting.
Must publish Bi-annual report.
In case of failure to contain inflation with
2-6% range for three successive
quarters, MPC will release a public
statement signed by all members.
^~130 words.
Moving to the third main recommendation:
#3: @Government give Cover fire to RBI
RBI Makes monetary policy to control money supply in the system [and thereby fight inflationary
and deflationary trends in economy.]
But RBIs monetary policy fails to yield result because of governments policies and subsidies.
Observe:
#: MNREGA:
Money increased in Juntaas hand? Yes
Productive infrastructure/assets increased =Hardly. (Most of those kuccha roads and ponds
get washed away in first rain.)
So in a way, more money in publics hand, without corresponding rise in some physical
goods/infrastructure/services. => leads to inflation.
Additionally, MNREGA=>less poors migrating to rich states to work as farm laborers=> the
farmers in those states have to arrange local laborers @higher wages=> food inflation.
+ lot of this money chowed down by Sarpanch, Patwari and Tehsildaar=> they give it local
money lender, who in
turn loans it to farmers @36% interest rate. Rajan has no control over this. His monetary policy
fails to control this.
#: MSP
In recent years, government kept increasing minimum support prices (MSP) of foodgrains (To
benefit farmers/vote bank politics.)
But APMC merchants are not ready to buy grains @such high price.
So, Farmers bring the grain to FCI (to sell it @Minimum support price declared by the
government.)
FCI buys it, but FCI doesnt have sufficient godowns= grains rotten @railway stations and eaten
away by birds, rats, dogs and cows.
Money increased in farmerss hand? Yes
Products/Goods/services increased in the economy? Nope. in fact foodgrain destroyed=> less
commodities/products/breads/biscuits.
Result= inflation.
+ even if this reaches to PDS shop, those shopkeeper themselves involved in hoarding and
black marketeering. So, inflation continues.
Ill-gotten money gets reinvested in gold, real estate etc (because black-marketer cannot deposit
in banks- else Income tax walla will track him down through KYC form.)
Again, Rajan doesnt have control over this, so his monetary policy will remain ineffective.
#: Fiscal Deficit
Without getting into all details:
Any type of deficit = as such bad. Because it shows government is spending beyond its
income.
Revenue expenditure = not good. [e.g. salary to staff]
Capital expenditure = good. [e.g. building new road/bridge]
Receipts= incoming money
Lets check the formulas to calculate various deficits:
Deficit formula
Budget deficit Total expenditure Total receipts
Fiscal deficit
Budget deficit + Borrowing.
(Total Expenditure Total Receipts) +
Borrowing
(Total expenditure + borrowing) [Revenue
Receipts + Capital Receipt]
Total expenditure [Revenue receipts +
(Capital Receipts non debt type)]
Total Expenditure [Revenue receipts +
(Recovery of loans +Other receipts)]
Primary
deficit
Fiscal deficit interest payment (on previous
loans)
Revenue
Deficit
Revenue Expenditure Revenue receipt
Effective
Revenue
deficit
Revenue deficit grant for creation of capital
assets
So what do we get from above formulas?
As such, any type of deficit is bad, because it shows youre spending beyond your income.
Sometimes it is good to overspend- e.g. A middleclass family takes loan to send their kid for
higher education. [because money will recover when kid starts job/business.]
Similarly, if government also overspends for productive purpose like building new bridges,
dams, canals and powerplants (i.e. capital Expenditure), then it is good, even if they run into
deficit.
^Atleast Keynesian economists believe so.
But in Modern Times, such goodwill expenditure also create more problems than they solve
1. because youre still overspending beyond your income,
2. even if bridges, dams, canals and powerplants are created itll take 20-30-50-100 years
http://mrunal.org/2014/02/economy-urjit-patel-committee-fixing-accountability-in-rbi-monetary-policy-committee-decision-by-majority-fiscal-deficit-part-2- 10/14
before the money is recovered through tolltax/selling electricity and water.
3. Besides governments tend to subsidize here also. So the capital Expenditure will not be
recovered quickly.
4. E.g. Kejriwal offering free water and cheap electricity. (After all it does come from some dam,
some canal, some powerplant.)
Therefore, Free Market economists argue that Government should not borrow money even for
capital Expenditure (building roads, canals, bridges and dams). Government should only spend
according to its income. And thus fiscal deficit should be kept minimum.
There are two ways to cut down fiscal deficit:
1. Government should increase its income (e.g. increase taxes, order PSU to give more dividend)
2. Government should decrease its expenditure (e.g. stop bogus schemes, reduce subsidies, sell
away loss making PSU, recruit less people and so on.)
But in real life scenarios, both solutions are difficult to implement, therefore instead of decreasing
fiscal deficit, government will keep issuing more bonds/Government securities to arrange additional
cash.=> fiscal deficit keeps increases. And High level of fiscal deficit leads to following problems:
1. Banks and investors buy these government securities.
2. As a result, less money left for businessman to get loans/investment => less business
expansion, less jobs=>GDP reduced.
3. In other words, fiscal deficit crowds out investment in private sector. Business loan interest
rates continue to remain high.=> Rajans statistical projections about money supply, will
become wrong. Thus monetary policy wont be effective.
High Fiscal deficit: the vicious cycle:
High Fiscal deficit=> S&P, Moody etc. reduce our Rating to junk level=> FDI, FII slows down.
But crude-oil, gold imports remain high => less incoming Dollars=> rupee weakens => crude
oil more expensive=> fuel inflation => inflation in everything transported by petrol/diesel.
And IF government starts giving subsidies on petrol/diesel, then more fiscal deficit=>vicious
cycle of weak rupee and high inflation continues.
Rajans monetary policy give much positive result in this case.
#: Loan Waiver
2008: Government announced debt waiver scheme for farmer. Accordingly, government paid
>60k crore rupees to the banks, on farmers behalf to settle their loans. This hurts in three ways
1. Fiscal deficit increased=> more problem as we saw above.
2. Rajans statistical projections for monetary policy go wrong.
3. Farmers get bad habit of not repaying loans on time, hoping that government will again waive
off their loans before general election.=> again NPA increases, banks are left with less money
to lend => banks will charge high interest rate on business loans (to keep profit margin
same)=> less business expansion = GDP, IIP declines.
Urjit Patels recommendations to Government
Given all these negative factors, Urjit Patel recommends government to do following:
1. Eliminate administered prices (MSP on foodgrains, LPG cylinders),
2. Eliminate administered wages (MNREGA)
3. Eliminate administered interest rates (interest subvention given to farmers.)
4. Implement Vijay Kelkar Committees recommendations on fiscal consolidation.
5. Religiously follow the guidelines of Fiscal responsibility and budget Management Act (FRBM).
6. At present fiscal deficit is ~5% of GDP. Reduce this to just 3% of GDP, by 2016-17.
Chindu
Waah Urjit bhai waah. Youve given some radical
recommendations.Lejin Hum nahi sudharenge(well not
reform and continue to give truckload of subsidies and
freebies before election.) Just observe:
1. Weve increased number of subsidized LPG cylinders from 9 to 12 => subsidy burden
increased by 5000 crore.
2. Previously 6th Pay commissions recommendation cost us Rs.20000 crores. Now Weve
formed 7th Pay commission under Justice Mathuor. You can be damn sure itll cost more than
Rs.20000 crores.
3. And before the Model code of conduct is announced, we may launch a few more schemes,
freebies and highest MSP for farmer.
Rajan
Then I better just run away to Nepal, Dubai or Bangkok
than try to fix the inflation mess through monetary policy.
Urjit Patel: Misc recommendations
1. Create standing deposit facility (similar to MSF.)
2. Reduce SLR rate as per basel III framework. (Nachiket Committee said remove SLR
completely).
3. Governments cash and Debt management function should be under a separate Government
body. (and not with RBI)
4. Government should not give directives to public sector banks on interest rates.
5. Exchange rates related. (QE, Tapering.)
6. Fixed income financial products (e.g. various maturity plans, Non-convertible debentures, small
savings scheme etc.): = for TDS and tax benefits, treat them similar to bank deposits. Thatd
motivate people to save into them rather than in gold.
Mock Questions
1. Find correct statements
1. Primary deficit cannot be higher than fiscal deficit
2. Primary deficit is obtained by deducting interest rates from Revenue deficit
3. Both A and B
4. Neither A nor B
2. Find Incorrect statements
1. Fiscal deficit cannot be lower than budget deficit
2. Fiscal deficit cannot be lower than Revenue deficit
3. Both A and B
4. Neither A nor B
3. Effective revenue deficit means
1. Revenue deficit + Interest payment
2. Revenue deficit Borrowing
3. Revenue deficit + grant for creation of capital assets
4. Revenue deficit grant for creation of capital assets
4. RBI governor is__
1. Selected by a panel consisting of Finance minister, commerce minister and the leader of
opposition in Lok Sabha
2. Answerable to the parliaments standing Committee on finance.
3. Both A and B
4. Neither A nor B
5. (A) In the recent years, RBIs monetary policy has failed to contain inflation. (R) High level of
subsidies and fiscal deficit reduce the impact of monetary policy on ground level.
1. Both the statements are individually true and Statement R is the correct explanation of
Statement A
2. Both the statements are individually true but Statement R is not the correct explanation of
Statement A
3. Statement A is true but Statement R is false.
4. Statement A is false but Statement R is true.
Q6. Urjit Patel Committee has recommended setting up a monetary policy Committee. Which of the
following statements are correct in that regard:
1. Members will be chosen by a panel of RBI governor, Finance minister, commerce minister and
the minister for corporate affairs.
2. Their salaries will be charged upon the consolidated fund of India.
3. They cannot be removed from office without a proved misbehavior and voting in both houses on
such motion.
Answer choices
1. Only 1 and 2
2. Only 2 and 3
3. Only 1 and 3
4. None.
Descriptive
(GS2-regulatory bodies)
What are the recommendations made by Urjit Patel Committee, to bring more
accountability in the monetary policy formation in India? (5m | 100 words)
Write a note on the salient recommendations by Urjit Patel Committee to strengthen the
monetary policy framework in India (10m | 200 words)
(GS3) Examine the role of Minimum support prices and farm subsidies as the Factors
responsible for inflation in India. Do you agree with Urjit Patel Committees recommendations
for removal of such administered prices and subsidies? Justify your stand. (10m | 200 words)
Interview
1. Urjit Patel Committee has recommended RBI to keep repo rate higher than CPI. This type of
hawkish policy to combat inflation, will hurt the growth momentum. Do you Agree?
Yes/No/Why?
2. Urjit Patel Committee says bring down fiscal deficit to 3% of GDP by 2016. Do you think this is
even plausible? Yes/no/why? If youre made by the finance minister of India, how will you
address the problem of fiscal deficit?
3. In the recent years, RBIs monetary policy has failed to put much impact on inflation. If youre
made the governor of RBI, how will you address this problem?
4. Suppose youre the Finance minister of India, and have to pickup the next governor of RBI.
There are two candidates- both man of high integrity and impeccable career record- one is an
IAS, who has long served in finance, commerce and corporate affairs ministries. And the
second candidate is an IIM graduate with long experience of teaching economics at prestigious
institutions abroad, and working with IMF but he holds a US Green card. Which one will you
select and why?
Visit Mrunal.org/Economy For more on Money, Banking, Finance, Taxation and Economy.

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