In our previous article, ‘Making RBI Accountable’ (IE, November 25), I had presented data on Indian inflation over the past year, and concluded that neither on growth nor on inflation has the RBI conformed to any known “models” of central bank behaviour. I had also argued that there was reasonable evidence to conclude that the RBI/MPC had not been very transparent, or consistent, in its guidance and that by allowing the real repo rate (nominal repo rate minus year-on-year CPI inflation) to triple over the last year to more than 3 per cent, its policies had hurt both growth and employment.
There is no question in my mind — or in the minds of most experts — that the MPC should be completely independent in the formulation of monetary policy. Some have suggested that if some government officials believe the real repo rate should be lowered, then all Prime Minister Narendra Modi needs to do is call up Urjit Patel and tell him that he wants the rate lowered. Rarely have I heard worse nonsense than this. Most countries of the world, including India, want their central bank to be independent, warts and all.
But the problem we are facing in India is rather sui generis — the central bank is going against all known models of central bank policy. Therefore the question arises, in the immortal words of Lenin, “What is to be done”? My simple proposal, which should both preserve independence of the central bank and make the RBI more accountable, is as follows: Change the RBI Act, if need be, to require the RBI governor (as lead representative of the MPC), to testify to Parliament twice a year. In separate testimony in both houses of Parliament, the lawmakers can ask questions of the RBI governor and the governor can respond.
Though I have repeatedly asked for clarification of the RBI memo on fiscal deficits, the RBI has chosen not to respond. Just to reiterate, in my note I have stated that important results pertaining to the RBI policy on fiscal deficits causing inflation cannot be reproduced. Worse, the RBI may have “cherry-picked” the data to suit its (ideological?) conclusion that the government policy on loan waivers will have a large impact on the consolidated state plus centre fiscal deficits. This expansion of fiscal deficit of 1 per cent of GDP due to loan waivers (RBI estimate) will, the RBI concludes, lead to a large 0.5 per cent increase in CPI inflation. Note that at present we (including self) are in the wilderness about (i) the actual magnitude of loan waivers this fiscal year; and (ii) more importantly, the impact it would have on CPI inflation, the principal concern of MPC policy.
What is the empirical evidence for the argument that an expansion of fiscal deficits leads to an increase in CPI inflation? The RBI did not use, in its estimation with quarterly data, the information contained in the data for the years 1996 to 2005 (1996 is the starting year for the quarterly GDP data series). The table shows three-year averages of the two variables of concern — fiscal deficit and CPI inflation. Looking at the period 1996 to 2004 (the data omitted by the RBI, and omitting the onion outlier year of inflation in 1998), annual inflation declined from around 6.6 per cent to 4 per cent. The fiscal deficit expanded from 8 per cent to 9.4 per cent of GDP. If the RBI had included the data from 1996 to 2005, as I show in my note, they would have found that there is no relationship between fiscal deficits and inflation for the long time-period 1996 to 2016.
Now let us look at the data considered by the RBI on fiscal deficits and inflation, 2006 to 2016. During this time-period, there is a sharp increase in inflation — from around 6.5 per cent to 9.9 per cent (year ending 2013), and then a sharp decline to 4.5 per cent in 2016. The trajectory of the absolute value of the fiscal deficit in the same period follows that of inflation — from 5.7 per cent to 8.3 per cent, and then a sharp decline to 6.6 per cent in 2016.
You don’t need a complicated estimation procedure as the RBI has done in its note to conclude that the period 2006-2016 will likely yield to a significant statistical relationship between increases/decreases in the absolute fiscal deficit and increases/decreases in CPI inflation. Ignoring the 1996 to 2006 data is the clearest, and obvious, form of cherry-picking the data, an intellectual “crime” that the RBI seems to have willingly committed. Such actions will be rendered impossible if India were to introduce the policy of jawabdehi.
In English, jawabdehi means accountability. The idea behind it is not new. Indeed, it is as old as 1978 when the Humphrey-Hawkins Act was introduced in the US. The Act of October 1978 states: “To assert the responsibility of the Federal Government to use all practicable programs and policies to promote full employment, production, and real income, balanced growth, adequate productivity growth, proper attention to national priorities, and reasonable price stability, to improve the coordination of economic policy-making within the Federal Government. Attainment of these objectives should be facilitated by setting explicit short-term and medium-term economic goals, and by improved coordination among the President, the Congress, and the Board of Governors of the Federal Reserve System (emphasis added).” It is worthwhile to quote from our own Finance Act of 2016, the one that established the MPC: “And whereas the primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth. The Central Government may, if it considers necessary, convey its views in writing to the Monetary Policy Committee from time to time.”
Both the US FED and India’s MPC have very similar goals — price stability with full employment. By experience, the US found it fit to introduce legislation to make the FED accountable to its own objectives. Should we not do the same in India? How will the introduction of jawabdehi help? Can we trust our parliamentarians to ask relevant questions, let alone the right ones? Equivalently, can we trust the RBI/MPC to deliver honest (true to its own goals) policy? Can we trust our “analytical” experts not to be cowed down by the RBI and be honest in their appraisal — a point also made, in the same context, by Chief Economic Advisor Arvind Subramaniam? Three questions — answers to the latter two we know, which is No.
In the US, the Humphrey Hawkins testimony is one of the most important FED events — it is televised, and both the politicians and the FED governors perform beyond expectations. No reason it will not happen in India. All we are saying is “give accountability a chance”. It is a win-win proposal for all, with zero downside — the country is better off, the RBI/MPC is better off, and even the “follow-the-RBI” analysts may begin to do some much-needed, independent, and honest analysis. At the time of writing, the RBI-MPC’s decision of December 6 is not unknown. Regardless of what the MPC does (rate hike, stay pat, or rate cut), my proposal deserves consideration. The only goal of the jawabdehi proposal is to bring about accountability, not rate cuts or rate hikes.