Insights into Editorial: Why RBI governors need a longer tenure
06 July 2016
A survey conducted by the Bank of International Settlements in 2009 showed that the average tenure of a central bank governor worldwide is between five and six years. However, 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.
What is the main concern?
According to experts, a three-year term for the central bank chief is not sufficient.
How RBI governor is appointed in India?
In India, the appointment process is entirely a political one. Though an Appointments Committee is the formal vehicle designated to shortlist candidates for the job, in reality, the Prime Minister’s Office chooses the governor after consulting the finance ministry and the outgoing governor.
Moreover, there are no stipulations in Indian law regarding the qualification of governors, or even for those who will be nominated by the government for India’s first monetary policy committee. An economics or finance background is not de riguer for the job, as is evinced by the record of those who have been appointed to the top job.
Why longer tenure is necessary?
- Since India is moving to a new rules-based monetary policy framework, a longer and more certain tenure is necessary.
- Apart from monetary policy, RBI also looks after banking supervision, currency market, and has an interest in maintaining overall financial stability in the economy. Hence, a longer tenure will allow the governor to plan better.
- A more clearly defined term for the governor will also help reduce uncertainty in financial markets.
- Various studies have also shown how central bankers who lived under the fear of recall were less effective in their duties.
- A fixed term is also widely seen as a mechanism to reduce the vulnerability of the central banker to political pressure.
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.
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.
- However, longer terms by themselves don’t necessarily translate into better outcomes. 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.
What would be an appropriate term for the RBI governor?
There is no clear indication of what is the optimum tenure for a central bank chief. The economic literature also doesn’t offer much guidance in this respect.
- However, a five-year term for the governor will 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.