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Political role in inflation targeting imperative

Gyanendra Keshri, Executive Editor, INCLUSION

Finance Minister Arun Jaitley

The Reserve Bank of India (RBI) has been hawkish on policy rates for the past four years to contain inflation. The central bank has maintained tight monetary policy despite reservations from the elected representatives and the government. What’s worse, the hawkish stance had little perceptible impact on the price rise, as the inflation remained stubbornly high.

This raises question mark over the effectiveness of the RBI policy on inflation. The time has come now to overhaul the monetary policy framework and align it with the best global practices. The good option would be moving towards a monetary policy committee (MPC) system, in line with the UK and some other advanced economies. For example, in UK, a nine-member committee headed by Governor of the Bank of England, meet every month and decide on the country’s monetary policy. The government sets a target for the inflation, and the committee strives to achieve that target through the monetary policy action.

In US, a 12-member Federal Open Market Committee decides on the monetary policy that includes decisions on interest rates, money supply and exchange value of dollar.

India needs to replicate similar system. Finance Minister Aurn Jaitley had announced in the Union Budget speech in July that the government strives to have a modern monetary policy framework to meet the challenges of an increasingly complex economy. Three months have passed, and yet no clarity has emerged.

The monetary policy framework must have representations from the elected representatives and the government as inflation has huge political repercussions. Several governments in India as well as other parts of the world have been ousted from the power due to their inability to rein in inflation. Failure in containing price rise was among the major reasons for Congress party-led alliance’s electoral drubbing in the national election earlier this year.

The monetary policy committee should have representations from the government and the elected representatives. In UK’s monetary policy committee, four out of the nine members are directly appointed by the Chancellor. 

Under the present framework, the RBI is responsible for setting the inflation targets as well as formulating the policy to achieve that goal. During Manmohan Singh-led UPA government, differences between the central bank and the government came out in the open. P Chidambaram, as finance minister, had expressed his unhappiness over the RBI monetary policy stance several times, advising the central bank to abide by the government policy to promote economic growth.

Conflicts between Chidambaram and then RBI Governor D Subbarao had come into open over the policy rate cuts. The RBI maintained hawkish approach on interest rates, despite a strong pitch from the finance minister for lowering the rates to revive growth.

Subbarao’s successor Raghuram Rajan has also maintained hawkish approach on interest rates ignoring the finance ministry’s advice. Interestingly, both Subbarao and Rajan had advocated for the growth friendly monetary policy when they were at the North Block in the national capital. Before moving to Mumbai’s Mint Street, Rajan was chief economic advisor in the finance ministry, while Subbarao had served as finance secretary. Out of the 33 monetary policy announcements in the past four years, the RBI has hiked rates on 15 instances. It was mostly done during the tenure of Subbarao – 12 times. Sadly, inflation remained stubbornly high – Consumer Price Index (CPI) inflation at around 10 per cent while Wholesale Price Index (WPI) inflation 7-8 per cent during most part of the last four years, against the RBI’s unofficial target of 4-5 per cent.

Clearly, we see here that the RBI has not succeeded in containing the inflation. The people though their votes often punish the elected representatives for such failures.

One important aspect of the monetary policy should be future guidance. It should not be just a reaction on a specific data on inflation or growth. It’s more about a judgment on the prevailing economic scenario and what holds in the future. The judgments of a diverse and independent group of experts are more likely to be correct than one or two individuals.

Moreover, the committee should be made accountable to the parliament. The lawmakers should have the authority to quiz the particular member of the committee on what guided him to take that decision.

The monetary policy committee system will ensure more transparency in the decision-making and ensure better coordination among the government and the central bank. This is critically important for attracting investments and reviving economic growth.  

(Gyanendra Keshri can be reached at gyanendra@skoch.in)

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