Dealing first with India’s central bank, the RBI’s current role is an appropriate one.  So much is apparent from a consideration of two aspects of India’s financial architecture; currency options and the role of market participants other than banks.

Currently, participating currency options traders must be registered with the Securities and Exchange Board of India (SEBI) and follow its guidelines for position limits, margins, surveillance and disclosures. At the same time, the RBI retains the power to modify eligibility, limits, and margins, or take any action required to ensure the stable and orderly development of the foreign exchange markets.

In the case of market participants other than banks, the 2006 amendments to the RBI Act empowered the RBI to give directions to market participants other than banks. But the amendment did not touch trading procedures; regulation of these remains with SEBI.

Both aspects of India’s financial sector have been successful. In both cases, SEBI (the sectoral regulator) retains oversight of the details of a sector, and the RBI has general oversight of the system.  This dual regulation allows flexibility, but also allows the RBI to act as a macro safety net. India’s strong performance during the global financial crisis is testament to the effectiveness of this system.

Thus, by devolving power away from the RBI, India is brushing aside the lessons of the crisis. But this devolution of power has another serious consequence; it places more power in the hands of elected officials. Specifically, although the Financial Stability and Development Council would theoretically be an independent body, the make-up of the council means that it would effectively be government-controlled.

Giving more power to politicians may seem to fulfil democratic objectives.  But in fact, this transfer of power will distort India’s financial sector, as the financial sector will be forced into funding the inefficient government sector. In addition, the average politician has poor organising ability and sees foreign transactions as an opportunity to make money. This short-termism would slow down the functioning of the Indian economy.

At the same time, the current Indian regulatory structure is not perfect. The current focus on stability comes at the expense of development, which proceeds slowly.

But there is a solution; convert the Financial Stability and Development Council into a strengthened HLCC (High Level Coordination Committee).

The idea of a strengthened HLCC has several advantages.  First, the legislature would be able to assign responsibility to a single regulator, and could impose clear time lines so as to fulfil the twin objectives of stability and development. But this assignation of responsibility would not come at the expense of the independence of the markets, who would retain their freedom to design products.

Second, a strengthened HLCC would strengthen sectoral regulation, which would in turn aid a focus on development. For instance, trading would remain the primary responsibility of SEBI.  Where policy or systemic issues arose, RBI involvement would be needed.  But the reinforcement of the HLCC would mean that the RBI could intervene with a specific mandate for market development.

Third, a strengthened HLCC would assist in the development of liquid markets, and deep liquid markets would improve the transmission of monetary policy. Specifically, strengthening the HLCC would allow SEBI  to become involved in the regulation of exchange procedures. Although the Clearing Corporation of India Limited was floated by the RBI, and performs many exchange related functions, involving SEBI in regulation of its trading procedures will help homogenise standards across exchanges, and will thus encourage the development of liquid markets.

Ultimately, regulators must be accountable to Parliament, but their technical knowledge and decisions must be respected. The RBI’s role should be retained, the HLCC’s role developed, and politicians should become involved only as a last and rare resort.

Ashima Goyal is Professor of Economics, Indira Gandhi Institute of Development Research (IGIDR), New Delhi.

 

This essay is edited from an article first published here at The Hindu Business Line.