RBI Governor Raghuram Rajan
Reserve Bank of India Governor Raghuram Rajan.

A proposal included in the revised draft of the Indian Financial Code (IFC) to scrap the independence of the Reserve Bank of India (RBI) in interest rate decisions would be detrimental to the country's economic prospects.

If the new proposal is implemented, the RBI governor loses the power to reject the decision made by the central bank's technical committee on key lending rates.

"We believe that tampering with the central bank's independence would make it difficult to anchor inflation expectations. This would weigh on India's economic prospects, particularly financial market stability," NDTV Profit quoted from a report by Moody's Analytics.  

The draft also proposes to set up a monetary policy committee (MPC) consisting of seven members, four of them to be nominated by the government.

"In particular, the recommendation that the majority of the panel be appointed by the government is a cause for concern given the track record of previous governments attempting to dampen the central bank's power and independence," said Capital Economics in a note.

Under the existing mechanism, the RBI governor consults a technical advisory committee before deciding on key policy rates, while having the discretion to accept or reject the recommendations of the committee.

The Central government's proposal to include four of its representatives in the committee is being seen as an effort to have greater control over decisions on policy rates.

"Moving to the new model would severely dent the RBI's competency: Credibility would be lower, politics would drive decisions, and transparency would be reduced," Moody's said.

With the government-appointed members forming a majority in the MPC, the independence of RBI in deciding key policy rates would be undermined.

"This is particularly true under the leadership of Governor Rajan since September 2013, whose reputation as a hawk has helped to bring inflation expectations down to single-digits for the first time since 2009," said Capital Economics.

Moody's said the IFC Bill is unlikely to get the Parliament's nod, taking into account severe criticism of the Bill.

The RBI is scheduled to meet on 4 August and the central bank governor Raghuram Rajan is widely expected to keep rates unchanged.

"Given that the government's Financial Code is still in its draft stages and is unlikely to be discussed in parliament until the winter, it won't have any bearing on the upcoming policy announcement on 4th August," Capital Economics added.

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