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India adopts flexible inflation targeting

Monetary policy panel to be set up via amendments to Reserve Bank Act

BS Reporters  |  New Delhi/Mumbai 

Raghuram Rajan
Raghuram Rajan

In a historic overhaul, the and the Reserve Bank of India (RBI) have agreed to put in place a framework to focus on flexible targeting, something the central bank has been pressing for.

The Consumer Price Index (CPI)-based targets — below six per cent by January 2016 and four per cent from 2016-17, with a band of plus/minus two per cent — are in line with the recommendations of a panel headed by Deputy Governor The panel was set up to suggest ways to reform India’s
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CPI-based for January 2015 stood at 5.1 per cent.

The new framework makes more accountable as now it will have to explain to the government if it fails to meet the targets. Economists say the targets will restrain from taking any aggressive or accommodating stance. This will put India on a par with other nations in terms of flexible targeting.

D K Joshi, senior director and chief economist, CRISIL, said, “This will make more transparent. Coordination between the government and will be strengthened further. But this also means we will have to see how food moves. Without food under control, keeping in the band prescribed beyond 2016 will be difficult. With the new framework being formed, there will be broader participation by the committee.”

While a part of the framework has come into effect from February 20, when and the inked an agreement in this regard, the government will have to amend the Act to constitute a committee, which will decide on the central bank’s stance. Though it is yet to be seen who the committee will comprise, the agreement hints it might be headed by the governor and the deputy governor in charge of will be the vice-chairman (as recommended by the Patel panel).

“The governor and, in his absence the deputy governor in charge of monetary policy, will determine the policy rate, as well as any other monetary measures to achieve the target,” the agreement says.

The pact, inked by Finance Secretary and Governor Raghuram Rajan, says the primary target of will be achieving price stability, while keeping in mind the objective of growth. will be considered to have failed in controlling if the rate of price rise, as shown by the CPI, exceeds six per cent for the three consecutive quarters beginning 2015-16. This will also hold true if falls below two per cent for three consecutive quarters beginning 2016-17, the agreement says.

The Patel panel had suggested the committee be made accountable for failure to achieve the target.

If the central bank fails to meet the target, it will have to state the reasons for this in a report to the Union government, the agreement says. The report has to propose remedial actions, too, and will have to give an estimate of the time within which the target will be achieved, the agreement adds.

“The Reserve Bank shall publish the operating targets and establish an operating procedure of through which the operating target will be achieved. Any change in the operating target(s) and the operating procedure in response to evolving macro-financial conditions shall also be published,” the agreement says. has to publish a document once every six months, detailing the sources of and forecasts for the period between six and 18 months from the date of the publication of the document.

Asked whether would now be compelled to take decisions on rate cuts out of fear of penalty, Chief Economic Advisor Arvind Subramanian said, “Decisions on whether to cut (interest rate) or not should be taken based on inflationary pressures and forecast going forward...A good central bank will take its decision based on data and outlook.”

On whether controlling was the sole responsibility of RBI, Finance Secretary said: “It is not a pass or fail test. It is just that you have to explain why you have been unable to do it.”

“This will make more accountable. This is good for accountability, transparency and credibility of monetary policy,” said Rupa Rege Nitsure, group chief economist at L&T Financial Services and part of the Ujit Patel committee.

After the constitution of the committee, it will be clear whether or not the government has agreed to the other recommendations of the Patel panel. Besides recommending the governor and deputy governor for the posts of the committee’s chairman and vice-chairman, respectively, the panel had also suggested the executive director in charge of be made a member. Two other members will be external, to be decided by the chairman and vice-chairman, on the basis of demonstrated expertise and experience in monetary economics, macroeconomics, central banking, financial markets, public finance and related areas. Both will be full-time members.

Sonal Verma, executive director and India economist, Nomura, said with this agreement, the government had formally mandated to move towards flexible targeting, in line with the recommendations of the Patel committee.

“We see this as a big positive for the economy, as it institutionalises the framework and ensures follows a prudent henceforth,” Verma said.

ALL EYES ON TARGET
  • Portion of framework came into effect on February 20, 8 months after it was proposed by the FM
     
  • CPI target for January 2016 has been set at less than 6%; 2-6% from 2016-17
     
  • will be considered to have failed if exceeds 6% for 3 consecutive quarters from 2015-16 and if it falls below 2% for 3 consecutive quarters from 2016-17
     
  • If fails to meet targets, it will have to state the reasons for this and propose remedial action
     
  • committee will decide on RBI’s stance

First Published: Tue, March 03 2015. 00:59 IST
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