Upside down: India’s monetary policy needs totally new guidelines, says report

It represents a whole new way of looking at things for India’s central bank, the Reserve Bank of India (RBI).

We’re referring to an interesting report on monetary policy-setting in India that was released this week. If, as is widely expected, its recommendations are accepted, it will overhaul India’s monetary policy-setting framework.

The report, headed by RBI Deputy Governor Urjit Patel, makes these key recommendations:

  • Fighting inflation should become the main policy objective of the RBI.
  • Policy should be decided by a monetary policy committee.
  • Consumer prices should be the main benchmark for gauging inflation.
  • Eventually, the central bank should set an inflation target of 4%, with a band of +/-2%.
  • Central  bank  policy should aim to reduce consumer price inflation to 8% within one year, and 6% by the end of 2015.  Then, the 4% target (with the band) should be formally adopted.

The 130-page report comes from a committee that was set up by RBI Governor Raghuram Rajan, who took over as the head of the central bank in September last year.

The importance of price stability

Maintaining prices, or price stability, ranks among the top goals of some of the world’s top central banks.

The Federal Reserve, for instance, has a mandate to promote stable prices, maximum employment and moderate long-term interest rates.

The European Central Bank’s main mandate is to maintain price stability, which means ensuring that the long-term inflation stays below, or close to, 2%.

The Bank of Japan has a dual mandate: to ensure price stability and the stability of the financial system

The implication of the RBI adopting price stability as the top mandate

India’s central bank currently has a mix of objectives: economic growth, price stability and financial  stability. By adopting price stability as the top goal, the RBI will be formalising what it  is already doing in practice through monetary policy — prioritising price stability.

In addition, as a Bloomberg report notes, “Focusing on consumer prices would bring the RBI’s approach closer to counterparts from Indonesia to Europe to the US.”

The central bank has been hiking interest rates repeatedly to tame inflation, which has become a persistent problem for the Indian economy over the past few years.

If consumer prices are taken as the new benchmark for guiding monetary policy, the Indian economy may be saddled with high interest rates for longer than expected.

The consumer price index is currently at a high 9.87% and pours cold water on the notion that the central bank might actually start easing policy rates soon ( that was, until today, the growing expectation among economic experts).

That expectation had been fanned by a fall in the wholesale price index (WPI) — the main benchmark currently used by the RBI to gauge price levels — to 6.16%, the lowest in five months.

But if the RBI accepts consumer prices as the main policy indicator, a falling WPI will no longer matter.

And interest rates will not fall.

For the entire RBI report, click on this link.

[Image Credit]


Leave a Reply

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

You are commenting using your 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