The Advisory Group has set out a inter-lined package of recommendations to enable India to move towards attaining internationally accepted best practices on transparency in monetary and financial policies. These recommendations would need to be properly sequenced and implemented over time.
Overall Concept and Context of Transparency
For purposes of this Report, transparency refers to an environment in which the objectives of policy, its legal, institutional and economic framework, policy decisions and their rationale, data and information relating to monetary and financial policies and the specifics of accountability of different agencies are provided to the public in an unequivocal and understandable manner and accessible on a timely basis. Transparency should not be viewed as an end in itself but a necessary prerequisite of good governance as policy actions pass through the test of public scrutiny (Paragraph 2.3).
The government, while setting out the framework of objectives, should, in the first instance, set out these objectives before the legislature and after endorsement by the legislature entrust to the central bank the task of attaining these objectives (Paragraph 2.4).
The Advisory Group is of the view that greater transparency would compel the authorities to bring about a greater degree of rigour in the formulation of strategies and choice of instruments and there are distinct advantages in a well-informed public debate on the objectives and instruments (Paragraph 2.5).
The Advisory Group recognises that there may be good reason for central banks not to disclose certain internal deliberations and documentation and near-term monetary and exchange rate policy implementation strategies. The authorities have to display considerable finesse while drawing the line on disclosures (Paragraph 2.7).
Monetary policy is only an aspect of overall economic policy and, therefore, there is need for convergence in policies as also transparency in other aspects of economic policy (Paragraph 2.9).
Critical Evaluation of India’s Compliance with International Codes
The RBI’s policies and operations largely conform to the IMF Code, but there are clearly a number of areas where improvements need to be made before India can be said to be fully compliant with the IMF Code. In the area of dissemination of information and the rationale of policies the RBI could be considered as being in accord with international best practices though there could be scope for further improvement, especially in providing precision to the monetary policy mandate and revealing of the process of monetary policy formulation. The Advisory Group recommends that the process of communicating the policy process, albeit on a post facto basis, needs to be institutionalised (Paragraphs 3.1 and 3.2).
The Advisory Group hopes that the National Commission to Review the Working of the Constitution would address the relevant constitutional issues as they apply to the RBI (Paragraph 3.3).
The Advisory Group is of the view that there is need for a transparent setting of objectives of monetary policy by the government and if the government finds these objectives as having certain adverse effects it can always alter the objectives, but it should be done in a transparent manner and made public and placed on the Table of the House and the government should seek Parliamentary deliberation of the objectives. This would then reduce the possibility of counterproductive conflict between the government and the RBI (Paragraph 3.6).
The Advisory Group emphasises that the present RBI Act is anachronistic and there should be an early move to amend the RBI Act to give sharper focus to the objectives of monetary policy. Transparency in monetary policy and greater responsibility and accountability for the RBI will be meaningful only if there is legislative amendment of the RBI Act to provide the necessary autonomy to the RBI to fulfil its responsibilities. The objectives of monetary policy should be set out by the government, as part of its overall economic policy package, and the government should seek Parliamentary debate on these objectives as also any changes in these objectives thereafter, which should be in the public domain (Paragraph 3.7).
The Advisory Group is of the view that it would be necessary to provide, through legislative amendments, reasonable security of tenure to the Top Management of RBI. This is essential if the RBI is to be clearly assigned specific responsibilities in the conduct of monetary policy and be accountable for the same to the wider public (Paragraph 3.9).
The Finance Minister Shri Yashwant Sinha in his Budget Speech for 2000-01 has said :
"In the fast changing world of modern finance it has become necessary to accord greater operational flexibility to the RBI for conduct of monetary policy and regulation of the financial system. Accordingly, I intend to bring to Parliament proposals for amending the relevant legislation."
The Advisory Group is gratified to note this commitment and urges that early action should be taken on the intention set out in the Budget Speech to amend the relevant legislation to accord greater operational flexibility to the RBI for conduct of monetary policy and regulation of the financial system (Paragraph 3.10).
Process of Monetary Policy Formulation
The Advisory Group recommends that the determination of interest rates should be exclusively a monetary policy function. There should be well calibrated legislative measures to separate debt management and monetary policy functions. The government should set up its own independent Debt Management Office to take over, in a phased manner, the present debt management functions discharged by the RBI. The Advisory Group recognises that separation of debt management and monetary policy is a necessary but not a sufficient condition for an effective monetary policy which would also require a reasonable degree of fiscal responsibility (Paragraphs 4.2, 4.4 and 4.5).
The Advisory Group is of the view that what the RBI needs, by way of autonomy is headroom to operate monetary policy and this it would have once debt management is separated from monetary policy and the fisc is in reasonable balance. Over a phased period, as debt management is gradually distanced from monetary policy, the government and RBI should progressively work towards greater clarity in publicly setting out the objectives of monetary policy. The RBI should evolve a move to greater transparency is setting out the process of monetary policy formulation so that accountability of the RBI can be properly assessed (Paragraphs 4.6 and 4.7).
The Advisory Group recommends that with a view to moving towards a more transparent system it would be best to veer towards prescribing to the RBI a single objective while the government could have for itself a clearly set out hierarchy of objectives for which it could use its other instruments of policy. There is much merit in the authorities clarifying issues in monetary and financial policies in simple language intelligible to the general public (Paragraph 4.8).
Illustratively, the government can unequivocally set out to the RBI a medium-term inflation objective, say over a prospective three year period, and while fixing this objective the government can take cognisance of other objectives and the government can retain the right, with Parliamentary endorsement, to reset the single objective in the light of evolving developments. The initial statement and consequent resetting of the objective should be done transparently and the rationale of the change should be fully explained. For purposes of credibility, frequent resetting of the objective, for a particular period, should be the exception rather than the rule (Paragraph 4.9).
Transparency in Policy Formulation
The Advisory Group recommends that the RBI should set up a seven member Monetary Policy Committee (MPC) as a Committee of the RBI Central Board. MPC consisting of the Governor, the three Deputy Governors and three other members drawn from the RBI Central Board. The members of the MPC should be knowledgeable in the areas of macro economics, monetary analysis, central banking policy and operations and banking and finance. More importantly, to ensure against any conflict of interest, the three Board members on the MPC should be independent professionals. The Advisory Group recommends that the MPC be set up early so as to give the MPC some time to work out its modalities and to undertake a few trial runs before the formal procedures are put in place starting from say the next financial year (Paragraph 5.2).
The Government of India should consider setting out to the RBI a single objective for monetary policy viz. the inflation rate. Once the single objective is set out the remit of the MPC would be clear and the RBI should be given unfettered instrument freedom and held fully accountable for attaining this objective. There is some merit in having an overriding provision under which the government can give a directive on monetary policy to the RBI but this should be in writing and in specific terms and applicable for a specific period; this should require Parliamentary endorsement after being placed on the Table of the House (Paragraphs 5.3, 5.4 and 5.6)
The Advisory Group recommends that there should be a monthly meeting of the MPC on a predetermined date, such as the last Wednesday of the month. A convention should develop wherein the RBI should time its measures immediately after the MPC meeting. A short statement should be issued immediately after the meeting of the MPC even when no measures are envisaged. The minutes of the meetings of the MPC should be made public with progressively increased details over time. The RBI should develop a healthy tradition of accepting the recommendations of the MPC save in very exceptional circumstances and in such cases the RBI should publicly justify its actions (Paragraph 5.7, 5.8, 5.9 and 5.11).
Transpararency in Other Financial Policies
Banks and other financial institutions owe it to their depositors to provide relevant information on performance in simple language easily understood by depositors. While stressing the need for greater disclosure the Advisory Group recognises the need for legitimate protection of proprietorial information (Paragraph 5.14).
The Advisory Group stresses that where there is regulatory forbearance it should be undertaken transparently. The regulatory regime should be rule based with minimum of discretion. Such a regime would obviously reinforce transparency (Paragraph 5.15).
The Advisory Group commends the recent RBI initiative to release a Discussion Paper on Prompt Corrective Action (PCA) and it is hoped that after receiving appropriate feedback the RBI would put in place a PCA regime as part of a commitment to adopt the international best practices and comply fully with the Core Principles of Supervision (Paragraph 5.17).
The regulatory/supervisory authorities in India should give early consideration to introducing, in a phased manner, a practice of disclosure of adverse supervisory action. The Advisory Group recommends that when penalties are imposed, however small, they should be publicised; minimal but timely adverse action would alert all stakeholders viz. owners, depositors and employees and there would be early convergence to least cost remedial action. A cardinal principle of sound regulation/ supervision should be that it should never be varied over the business cycle. It is entirely a monetary policy function to deal appropriately with the business cycle. Per contra, monetary policy should not be diluted to make it less costly for financial intermediaries to comply with prudential norms (Paragraphs 5.18, 5.19 and 5.20).
In terms of transparency, the setting out of the principal objective of monetary policy would also provide the broad contours for exchange rate policy. The Advisory Group is of the view that the Indian disclosure standards compare favourably when considered against the disclosure template set out in the BIS Report on Enhancing Transparency Regarding the Authorities Foreign Currency Liquidity Position (September 1998). The Advisory Group recommends that the RBI should continue to be in the avant garde on disclosure of forward liabilities. This is an instance where Indian practices are ahead of international "best practices". Revealing the maturity pattern of forward liabilities would help stabilise market reaction to variations in the reserves resulting from maturing forward purchases/sales (Paragraph 5.21).
The Advisory Group recommends that the efficiency of the forex market would be greatly enhanced if, without in any way compromising the freedom of action on exchange rate policy, the RBI were to reveal, on a regular basis, separately, its direct and indirect intervention operations (Paragraph 5.22).
The Advisory Group is of the view that for an effective transmission of monetary policy the changes in the various segments of the financial markets should be allowed to traverse freely through different segments of the financial markets (Paragraph 5.23).
