Targeting inflation

RBI Act changes plug many gaps, but challenges remain

The details of the amendments to the Reserve Bank of India (RBI) Act, published in this newspaper, show that the specific inflation targets that the central bank will be expected to reach under the newly legislated monetary policy framework would be determined by the government and notified separately in the Official Gazette. The government will, of course, consult the RBI before arriving at the inflation target that will continue to be linked to the Consumer Price Index - a practice that has been in vogue for the last several months.

The government deserves to be complimented for making sure that the inflation target is not part of the law. It is reassuring that as far as setting the inflation target is concerned, the government has not made the same mistake that the Congress is committing by irrationally demanding the inclusion of the goods and services tax (GST) rate in the Constitution Amendment Bill and which the government has rightly rejected. The Fiscal Responsibility and Budget Management Act too did not have the fiscal deficit target included in the law itself. A periodic review of the inflation target after five years should serve the purpose, as long as necessary notifications in this regard are routinely gazetted. It is equally important to recognise that, contrary to apprehensions in certain quarters, the central bank's autonomy is unlikely to be undermined by the new provisions in the RBI Act. The government would determine the inflation rate in consultation with the RBI and that is how the new monetary policy framework should be operated.

On the whole, the new arrangement is a step in the right direction. The RBI governor will chair the six-member monetary policy committee and he will also have a casting vote in case no majority view on the monetary policy stance emerges. Sufficient transparency is also ensured by making public the resolution adopted by the Committee even as its proceedings would be kept confidential. The composition is such that the Governor can always assert his moral right to guide the direction of the policy to help the central bank meet its commitment to achieve the inflation target even while ensuring growth - which is the broad objective of monetary policy.

The only doubt pertains to the manner in which the three experts would be appointed. The amended law stipulates that three members will be selected through a search-cum-selection committee to be headed by the Cabinet secretary. Interestingly, this committee has a preponderance of government nominees and the RBI governor, though represented on it, is only a member. The real challenge, therefore, would be to identify and appoint the three external members, who should not only be erudite in the areas of banking, finance and monetary policy, but also enjoy integrity beyond doubt. They are also not expected to have any interests or associations with banks or any links with entities that may be under scrutiny for financial irregularities. Identifying such candidates will not be easy. The real challenge for the monetary policy framework will, therefore, be to ensure the quality and integrity of the three external members on the Committee, who will play a key role in helping it frame a monetary policy that is appropriate for the economy.