An expert committee appointed to examine the current monetary policy framework of the Reserve Bank of India (RBI) has suggested that the apex bank should adopt the new CPI (consumer price index) as the measure of the nominal anchor for policy communication.
The expert committee was headed by Urjit R. Patel, Deputy Governor of the Reserve Bank of India.
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.
“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 government towards their elimination.
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.