Monetary policy needs a single objective. The Urjit Patel committee report shows the way forward.
The report of the Urjit Patel committee, which has recommended that the RBI should be a flexible inflation-addressing central bank that targets the CPI at 4 per cent, is a welcome step towards making it a modern central bank. As these columns have long argued, the monetary policy framework for India needs to clearly state the single predominant objective of policy.
The lack of such a measure and the absence of accountability owing to a multiple-objective approach has given us persistently high inflation since 2006. A single defined aim will allow the RBI to focus on how to handle inflation and strengthen its research capability for doing so, as well as be accountable for the same. The framework and voting mechanism for the monetary policy committee (MPC) will make the RBI function like a modern central bank that manages market expectations based on its views. The macroeconomic stability provided by low and stable inflation will deliver higher GDP growth in the long run.
An important element of the recommendation is that CPI, which is the basket the common man cares about, will be the inflation rate that the RBI will target. There is no point in targeting the WPI, which is no one’s consumption basket. All other countries that address inflation also target consumer prices. A 4 per cent inflation rate is realistic in India and will help anchor inflationary expectations.
The flexibility around it provided by a plus-minus 2 per cent band is sensible, given the weak monetary policy transmission mechanism in the country.
The RBI should immediately accept the recommendations of the committee on the single objective and measure of inflation. The policy community has already debated this issue for a decade and the three major committee reports on financial sector reforms — the Raghuram Rajan committee, the Percy Mistry committee, and more recently, the Financial Sector Legislative Reforms Commission (FSLRC) — have all recommended it.
The Indian Financial Code (IFC) recommended by the FSLRC should now put this in the law, as in other countries. Once codified in law, the RBI will be accountable to Parliament and no governor will be allowed to take arbitrary decisions about monetary policy that violate the decision of the MPC. That will add teeth to the monetary policy framework of the RBI.
If accepted by the RBI, the committee report will be the first step towards voluntary adoption of governance-enhancing principles in the IFC and a significant step forward in making Indian regulators transparent and accountable.