Patel Report: Monetary policy for the common person
In recent years, India has been afflicted by high inflation and low growth. As is well known, inflation hurts the lowest strata of society which has no defences against it. In this context, the Urjit R Patel Committee Report to Revise and Strengthen the Monetary Policy Framework (January 21, 2014) provides signal service as it provides hope to the common person who is cruelly crushed by inflation.
The Growth-Inflation Tug of War
There is a perennial tug of war between those wanting inflation control and those pushing for higher growth. In India, there are powerful forces pushing for higher growth while those with societal concerns veer towards inflation control. Political economy imperatives point to the need for a fine balance between both objectives, but in practice, at the margin, inflation control is often given the go by.
In India, it is difficult for the Reserve Bank of India (RBI) to garner sufficient support to press on with inflation control when inflation is in single digits. But when inflation gets into double digits, there is considerable support for inflation control. When the RBI attempts to keep inflation down, there is trenchant criticism of the RBI and the government also indulges in overt criticism of the RBI, particularly in recent years.
Furthermore, policy focus is excessively on the Wholesale Price Index (WPI) while almost all countries use the retail Consumer Price Index (CPI). The fact is that the WPI generally provides greater comfort to the government as it calls for a less stringent monetary policy.
Path-breaking Patel Committee Report
The great merit of the Patel Committee Report is that it sets out a clear framework for monetary policy formulation and operations. The report unequivocally sets out that the nominal anchor for monetary policy should be the headline CPI-based inflation which closely reflects the cost of living. By using the headline (overall) inflation rate, the report moves away from the practice of explaining away inflation by assessing CPI inflation excluding food; such assessments are unrealistic as food is a very large component of the Indian consumer basket.
The roadmap set out by the Committee is to bring down the current CPI inflation from the present 10 per cent rate to 8 per cent in one year and 6 per cent in two years. The target for the medium- term would be an inflation rate of 4 per cent+/- 2 per cent. Interpreting this in simplified terms, monetary policy would slam the brakes whenever inflation threatens to rise above 6 per cent and the foot would go onto the accelerator if inflation moves below 4 per cent. It needs to be emphasised that the Committee does not envisage that all the woes of the economy can be set right only by monetary policy. The report recognizes that to attain the monetary policy objectives there has to be adequate fiscal correction. The broad policy framework set out by the Patel Committee should be of great comfort to the common person as it would alleviate the intense suffering inflicted by high inflation. As such, the Patel Committee report is truly path-breaking.
An important recommendation of the Patel Committee is the setting up of a five member Monetary Policy Committee (MPC) with voting which would decide on the policy interest rates of the RBI. The Committee would consist of the Governor, the Deputy Governor and Executive Director in charge of monetary policy and two full-time external members. While the MPC would have decision taking powers, it would be accountable for failure to attain the stipulated inflation targets.
Predictably, there would be criticism of the Patel Committee Report as it would be erroneously argued that inflation targeting is not desirable in a country with the complexities of India and that growth considerations would be under-emphasised. It would also be argued that many countries are moving away from inflation targeting. Critics of inflation targeting fail to recognise that it is not optimal to load a single policy instrument with multiple objectives. Furthermore, a policy instrument should be directed to achieve the objective it is best suited to achieve. Quite clearly, monetary policy is best suited to control inflation.
Far from thwarting the implementation of the report, various economic agents-government, industry and trade-must recognise that implementation of the report would contribute significantly to the general good and hence should be unequivocally supported.
Monetary Policy January 28, 2014
The Third Quarter monetary policy review for 2013-14 will be announced on January28, 2014. It would be desirable to keep the Patel Committee recommendations as a backdrop while formulating the policy. Advocates of a soft monetary policy would no doubt argue that GDP growth is sluggish, that industrial output is unduly low and that the balance of payments Current Account Deficit (CAD) is well under control. These advocates would argue for lower policy interest rates and wider access to RBI accommodation. Furthermore, it would be argued that the CPI year- on- year inflation has come down from 11.2 per cent in November 2013 to 9.87 per cent in December 2013.
As compared with the Patel Committee roadmap of cutting inflation to 8 per cent, the latest inflation rate of 9.87 per cent is far too high and hence there should be no question of either reducing the repo policy rate or widening access to RBI accommodation at the repo rate. In fact there is far too much access through the term repo facility and liberal open market purchases of securities by the RBI. If at all, from the viewpoint of the inflation indicators, there is a case for an increase in the policy repo rate and a reduction in RBI accommodation. Monetary policy works with a lag of about three quarters. To the extent the objective is to bring down the inflation rate, the appropriate policy response would be to tighten and not relax monetary policy.
Please Note: This article was first published in The Freepress Journal on January 25, 2013. Syndicated.
This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.
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