The expert committee headed by RBI Deputy Governor Urjit R Patel Deputy Governor of the Reserve Bank of India. The committee would be responsible to recommend the measures to revise and strengthen the Monetary Policy Framework by making it transparent and predictable submitted its 130 page report suggesting that inflation should be the nominal anchor as far as the policy framework is concerned. It recommends that the Reserve Bank of India (RBI) adopt a new CPI as the anchor for the policy. The report to revise and strengthen the Monetary Policy Framework has come out in favour of the Reserve Bank of India moving towards a flexible inflation targeting system. This approach to monetary policy is a product of the much-criticised “new consensus macroeconomics”, a school of thought that is credited with causing the recent global financial crisis. The objectives for monetary policy that the committee suggests are not only theoretically unwarranted, but also unjustified for the current state of evolution of India’s financial system.
The committee felt that inflation should be the nominal anchor for the monetary policy framework. The nominal anchor or the target for inflation should be set at 4 per cent with a band of +/- 2 per cent around it.
The panel also suggests that the government must bring down the fiscal gap down to 3 percent by FY17. Further, it says that administered setting of prices, wages and interest rate should be moved away from and everything should be market determined.
“It should be set by the RBI as its predominant objective of monetary policy in its policy statements,’’ the report said. “The nominal anchor should be communicated without ambiguity, so as to ensure a monetary policy regime shift away from the current approach to one that is centred around the nominal anchor,’’ it added. Subject to the establishment and achievement of the nominal anchor, monetary policy conduct should be consistent with a sustainable growth trajectory and financial stability, it added.
“The nominal anchor should be defined in terms of headline CPI inflation, which closely reflects the cost of living and influences inflation expectations relative to other available metrics,’’ the committee felt. “This target should be set in the frame of a two-year horizon that is consistent with the need to balance the output costs of disinflation against the speed of entrenchment of credibility in policy commitment,’’ the report said.
In view of the elevated level of current CPI inflation and hardened inflation expectations, supply constraints and weak output performance, the committee said the transition path to the target zone should be graduated to bringing down inflation from the current level of 10 per cent to 8 per cent over a period not exceeding the next 12 months and to 6 per cent over a period not exceeding the next 24 month period before formally adopting the recommended target of 4 per cent inflation with a band of +/- 2 per cent.
Since food and fuel account for more than 57 per cent of the CPI on which the direct influence of monetary policy is limited, the commitment to the nominal anchor would need to be demonstrated by timely monetary policy response to risks from second-round effects and inflation expectations in response to shocks to food and fuel, the committee pointed out.
The committee asked the Central Government to ensure that the fiscal deficit as a ratio to GDP (gross domestic product) is brought down to 3.0 per cent by 2016-17. “Administered setting of prices, wages and interest rates are significant impediments to monetary policy transmission and achievement of the price stability objective,’’ it said. As such, these required a commitment from the go
The Patel committee to revise and strengthen the monetary policy framework mooted a shift to the Consumer Price Index as the nominal anchor for inflation targeting and the setting up of a monetary policy committee headed by the governor with rate action decided by votes, the model followed by the US Federal Reserve. The FSLRC has recommended that price stability is a desirable goal in its own right, particularly in India, where inflation is known to hurt the poor and therefore the central bank must be given a quantitative objective that can be monitored by the central government for its monetary policy function.
Monetary policy committee
The Patel panel felt that the monetary policy decision-making should be vested with a monetary policy committee (MPC). It went on to recommend that the Governor of the RBI should be the Chairman of the MPC. It felt that the Deputy Governor in-charge of monetary policy could be the Vice-Chairman. The Executive Director in charge of monetary policy could be its member. It could have two external members. The full-time external members would have full access to information/analysis generated within the Reserve Bank. “They (external directors) should not hold any office of profit, or undertake any activity that is seen as amounting to conflict of interest with the working of the MPC,’’ it said. The term of office of the MPC could be three years, without prospect of renewal. “Each member of the MPC will have one vote with the outcome determined by majority voting, which has to be exercised without abstaining. Minutes of the proceedings of the MPC will be released with a lag of two weeks from the date of the meeting,’’ the committee said.
It said all fixed income financial products should be treated on a par with bank deposits for the purposes of taxation and TDS. With a sharp rise in the ratio of agricultural credit to agricultural GDP, the need for subventions on interest rate for lending to certain sectors would have to re-visited, it said.
In view of the cross country and Indian experience with global spillovers driving episodes of large and volatile capital inflows as well as outflows, the committee felt that a flexible setting of monetary policy by the RBI in the short-run was warranted. “This presages readiness to use range of instruments at its command, allowing,’’ it said. “With regard to inflows that are excessive in relation to external financing requirements and the need for sterilised intervention, the RBI should build a sterilisation reserve out of its existing and evolving portfolio of GoI securities across the range of maturities, but accentuated towards a ‘strike capability’ to rapidly intervene at the short-end. The central bank should introduce a remunerated standing deposit facility, which would effectively empower it with unlimited sterilisation capability. As a buffer against outflows, the RBI’s strategy should be to build an adequate level of foreign exchange reserves, it added.
The terms of reference of the Committee are:
• To review the objectives and conduct of monetary policy in a globalised and highly inter-connected environment.
• To recommend an appropriate nominal anchor for the conduct of monetary policy.
• To review the organisational structure, operating framework and instruments of monetary policy, particularly the multiple indicator approach and the liquidity management framework, with a view to ensuring compatibility with macroeconomic and financial stability, as well as market development.
• To identify regulatory, fiscal and other impediments to monetary policy transmission, and recommend measures and institutional pre-conditions to improve transmission across financial market segments and to the broader economy.
• To carefully consider the recommendations of previous Committees/Groups in respect of all of the above.
About the Author
Shubham Satoiya is a student of Rajiv Gandhi National University of Law (RGNUL), Patiala, pursuing B.A. LL.B. (Hons.), with Economics major as a subject. He is currently interning with the Model Governance Foundation.