Reserve Bank of India RBI

Why RBI governors need a longer tenure:

The outgoing governor of the Reserve Bank of India (RBI), Raghuram Rajan, recently told a parliamentary committee that a three-year term for the central bank chief is not sufficient. As India is moving to a new rules-based monetary policy framework, it is perhaps also time to put an end to the uncertainty and arbitrariness around the tenure of RBI governors.

Every governor after the 1991 reforms save Rajan has served for five years or more. But save for Y.V. Reddy, all of them were given initial three-year terms followed by extensions.

Central bank chiefs are normally appointed by the political leadership all over the world, but their appointment does not necessarily have to be politicised. Any government should avoid uncertainty by clearly defining the term of the governor. This will help in at least two ways. First, it will allow the governor to plan better. It is important to note that apart from monetary policy, RBI also looks after banking supervision, currency market, and has an interest in maintaining overall financial stability in the economy. Second, a more clearly defined term for the governor will help reduce uncertainty in financial markets.

So, if three years are not sufficient, and it is not very difficult to understand why, what would be an appropriate term for the RBI governor? The economic literature doesn’t offer much guidance in this respect, as was also highlighted by economist Indira Rajaraman in this newspaper last week. There is no clear indication of what is the optimum tenure for a central bank chief, though she cited econometric research that shows how central bankers who lived under the fear of recall were less effective in their duties.

The RBI governor has the shortest tenure among the heads of major central banks, with the possible exception of Brazil, where no fixed term is specified. Among the developed countries, the chairman of the US Federal Reserve is appointed for a term of four years which can be renewed, while the governors of the Bank of England serve a much longer term. The president of the European Central Bank has a non- renewable term of eight years. A survey conducted by the Bank of International Settlements in 2009 showed that the average tenure of a central bank governor is between five and six years.

However, longer terms by themselves don’t necessarily translate into better outcomes. Alan Greenspan was at the helm of the Federal Reserve for over 18 years and was widely credited for smoothing the business cycle. But things changed dramatically with the 2008 financial crisis and many now blame him for the excesses that were created in the financial sector. Therefore, what is perhaps needed is a balance. Ideally, the term should not be so short that it hampers longer-term thinking, and it should not be too long to block new ideas.

The new monetary policy framework seems to further complicate matters. The government has amended the RBI Act to create a monetary policy committee (MPC) that will have a term of four years. The inflation target will be decided by the finance ministry every five years. Clearly, a three-year term for the RBI governor does not make sense in this context. It will lead to misaligned incentives.

A five-year term for the governor will thus be more appropriate, and consistent with both the political cycle and the review of the inflation target. This will also provide continuity when the term of MPC members end. It will strengthen the independence of the central bank if the term of the governor is non-renewable. It will also help if the five-year term of the governor ends 12-18 months after the general elections so that there is stability at one end of the policy spectrum. Since India is changing the way monetary policy will be conducted, this is a good time to increase the minimum tenure of an RBI governor to five years.


Source: livemint.com

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