Parliament Should Set Inflation Target

Reining in the deficit and containing the inflation rate to between 3 and 5 per cent are crucial pre-conditions for full convertibility, says the report Inflation control is key to CAC as it has a bearing on the exchange rate. In fact, if the inflation goes beyond control, there is always a possibility of flight of capital

The Tarapore committee has strongly recommended a mandated average rate of inflation of three to five per cent for the three-year period when capital account convertibility (CAC) will be introduced in phases.

Inflation control is key to CAC as it has a bearing on the exchange rate. In fact, if the inflation goes beyond control, there is always a possibility of flight of capital.

In the monetary policy announced in April this year the RBI stated that it would seek to maintain the expansion in M3 in the range of 15 to 15.5 per cent and keep inflation rate at around 6 per cent in 1997-98. The committee has also commented on this fact while making its recommendations. Once the inflation rate is fixed, there should be an early empowering of the RBI on the inflation mandate approved by Parliament and only Parliament should alter that mandate.

The committee has said that once the mandate is given , RBI should be given the freedom to attain that target.

The committee has said that there should be clear and transparent guidelines on the circumstances under which the mandate could be changed.

This should empower the Reserve Bank of India with greater autonomy in its operations which will be required in context of the impending CAC decision

Among one of the pre-requisites for capital account convertibility is a stable fiscal policy and further recommendations have been given by the Tarapore committee yesterday to the Reserve Bank of Inda governor C Rangarajan.

The committee has recommended that the government take action on lines of the act governing the Government of New Zealand.

It has been noted by the committee that inflation in the developed countries has averaged around 3 per cent and in most of these countries the central bank receives a mandate for containment of inflation in a particular band.

This mandate , the committee felt, should be in the form of a medium-term inflation mandate by the Parliament. The revision in these rates can be done only by the Parliament. On its part, the Reserve Bank of India should ensure that it employs all the tools in its power to keep the inflation in this band of range.

As India moves towards capital account convertibility a higher rate of inflation would be destabilising and that it would spur a higher level of nominal and real interest rates which would be detrimental to the growth of the economy.

However the committee has cautioned that a very low rate of interest rates would result in outflow of capital from the country.