The move to strip Reserve Bank Governor of powers to set interest rates by transferring the authority to a broader panel is a step closer to reality with the Lok Sabha today approving the Finance Bill 2016.
The Finance Bill 2016 contained an amendment to the Reserve Bank of India Act of 1934 giving the central bank a mandate to target inflation.
"We have drafted the amendment (to the RBI Act) in consultation with the RBI so that inflation is reduced," Finance Minister Arun Jaitley said in his hour-long reply to the debate on the Bill.
The six-member monetary policy committee (MPC), which will include RBI Governor and three nominees of the government, will set interest rates to bring consumer or CPI inflation to pre-set targets.
"Inflation targets will be set once every five years," he said adding the MPC would have three representatives each from government and RBI with the central bank governor having the casting vote.
After the Finance Bill is approved by the Rajya Sabha, the process of setting up of the Monetary Policy Committee (MPC) will be set in motion.
Government will nominate three eminent persons to the MPC. No government official will be nominated to the MPC.
The remaining three members would be from RBI with the Governor being the ex officio Chairperson. Deputy Governor of RBI in charge of the monetary policy will be a member, so will an Executive Director of the Central bank.
Each member shall have one vote and in case of a tie, the Governor shall have a second or casting vote, according to the Finance Bill.
This means the governor will not have a veto power and can only be deciding factor in case of a tie. Presently, the Governor has overriding powers to accept or reject the recommendation of RBI's panel on monetary policy.
The government nominees to the MPC will be selected by a Search-cum-Selection Committee under Cabinet Secretary with RBI Governor and Economic Affairs Secretary and three experts in the field of economics or banking or finance or monetary policy as its members.
Members of the MPC will be appointed for a period of four years and shall not be eligible for reappointment, the Bill said.
The government will set an inflation target in terms of the Consumer Price Index (CPI) once in every five years. The inflation target will be decided in consultation with RBI and notified in Official Gazette.
MPC will meet at least four times in a year and the government may, if it considers necessary, convey its views in writing to the MPC from time to time.
RBI will every six months publish Monetary Policy Report explaining the sources of inflation and the forecasts of inflation for the period between six to 18 months.
If RBI fails to meet the inflation target, it shall in the report give reasons for failure, remedial actions as well as estimated time within which the inflation target shall be achieved.