Urjit Patel Committee on Monetarty Policy Framework – Some reflections

What does a RBI Deputy Governor do when he is appointed by the RBI Governor to look at a revamping mon pol framework (whatever that means)? Of course he looks at whether  the Governor has written on the matter and simply work around it. In this recent committee’s case, this is clearly the case. There is hardly any difference between what the Governor said in his 2009 report and what this comm says in 2013. (The same is true for Mor committee on financial inclusion). And then recent report on FSLRC also has similar ideas on RBI. One wonders what purpose do these committees serve other than generating hype.

Another thing which aids the Comm is that you need to just look around the central banks and see what they are doing. Lot of work has been done on this design aspect so makes it easier. No wonder the comm has picked up insights from central banks around the world – BoE, Fed etc. So soon, RBI will be in global company of central bank policies.

Much was already known about the committee and written upon. Things like targeting CPI, having an inflation target, forming a MPC etc have been written by several people in the past. So, the committee is bang on expected lines. Some thoughts:

  • The committee does not bite the core inflation bullet. So if the proposal goes through headline CPI will be the target.CPI has nearly 60% of food and fuel items and if you just follow  core, you are targeting just 40% of the index. That is really nothing to target. Moreover, food inflation hits inflation expectations so one has to be weary. This is a catch 22 situation really. If you target headline CPI you expose yourself to food shocks which could be persistent as seen recently. If you don’t hike you are doomed and if you hike you know it may not work. So you end up with high rates, low growth and still high inflation.
  • The committee says RBI should target CPI at 4% with a band of +-2%. This threshold level of inflation has always been there and explained by several RBI officials in the past. Most know RBI targets an inflation of 4-6%.
  • It says RBI should bring the inflation to 8% in next 12 months and 6% in not more than 24 months before adopting 4% target. Well, what does this mean now? Will RBI hike rates after the pause in Dec? You cannot say food prices are responsible for high CPI. This is a given now..
  • Another thing is markets have already moved to CPI. WPI has become a secondary data. So why should there be so much hype around this change which has already changed..
  • The next issue is who sets this inflation target. In BoE case, Govt does it. In Fed case, they have done it themselves. The comm does not really bring Govt into equation here which has obviously effected the government.
  •  On MPC, it says in India, the decision to make policy vests with Governor who is accountable to Government. These powers should be given to MPC which will have Gov as Chairman, DG for Mon Pol area as VC and two external members. What will other 3 DGs do? Moreover, how does it really matter whether policy is framed by Guv or MPC? Do we have cases where decisions have been made against the Guv/Chairman. At most there have been dissents but the Governor has usually won the battle. In India’s case till current Governor is around, one might not even see any dissent.
  • Again who appoints MPC members? If MPC is the way to go, the appointments should be made by the Government. Just like government appoints Deputy Governors for key policy roles, same applies to MPC members as well. They will be responsible for mon policy and their role is nothing different from Guvs/DGs. This will make them accountable to the Government as is the case everywhere. The powers with Governor could make MPC another cosy club. Some might say no this will lead to government intervention. Well if it could choose the current Governor, it can make appointments on MPC.
  • Things like semiannual inflation reports, writing letters in case targets are missed are like bells and whistles. BoE kept missing the inflation target and Governor kept writing letters but nothing much happened. It just became an exercise. The point is it works well in normal times but is ineffective in bad times.
  • The committee makes one major assumption of fiscal consolidation and asks government to stick to its fiscal plans. Well, this is where the trouble has been for recent years. It is not just fiscal consolidation but all kinds of policies which have led to sustained food and overall inflation. If government had remained discipline there was no real need for this framework. Much of literature celebrating successes of inflation targeting central banks is silent on the roles played by government/fiscal policy. It is as if just a change to inflation targeting has delivered the results. It was part of overall reforms which led to lower inflation in these economies. As the government became irresponsible before and during the crisis, the central banks of these economies are in trouble.
  • What was once seen as a gold standard (inflation targeting/IT), has come under huge scanner during this crisis. The central banks have been criticised for keeping a very narrow focus on inflation ignoring the other risks. The moment you get into IT, this is bound to happen. That is how these central banks have projected themselves.  So it is not really a magic pill as media suggests. In RBI’s case this even gets more interesting as it has always kept away from this global hype and stuck to indegenised version of mon pol balancing several things. And like everything in policy, there are trade-offs.  So by getting into IT, RBI will have to think of ways to manage its other tasks as well. With IT, people do not expect you to do anything else.

Ideally such committees (if they are to be floated again and again), should be floated by the Government. And then in consultation with RBI it can be implemented. Moreover, if these proposals came from the government they could have been implemented far more smoothly as both Government and Governor would be on the same page. It can be done much smoothly. And then FSLRC implementation would have anyways got us to the proposed model. Efforts could be made to speeden the effort.

The bottom line is yes this will be a new framework but in reality things are just the same and one has to stick to the basics. India has a much better record on inflation (historically) compared to its peers. This was not because of any framework really but because of its history and intent. RBI has always known inflation hits poor the most and as a result has stood against the tide to cut rates. Whenever inflation has remained persistent above threshold, RBI has acted to bring it down. The persistent inflation is usually because of some supply or fiscal shock. The RBI has been vigilant to inflation risks for much part of its history. Frameworks come and go, basics remain.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: