Updated: March 3, 2015 12:00:20 am
With the operationalisation of a modern monetary policy framework agreement signed between the Reserve Bank of India and the government announced in the budget, India has joined the ranks of major economies. The agreement binds the RBI to keeping inflation below 6 per cent by January 2016, with the target for 2016-17 and subsequent years pegged at 4 per cent plus/ minus 2 per cent. According to the agreement, the RBI will determine the policy rate as well as any other monetary measure to achieve the target. If the RBI is unable to achieve its target for three consecutive quarters, it will have to explain to the government the reasons and the remedial action it proposes — much in line with agreements in countries such as the UK. This provides legitimacy to what the RBI has been doing for years. But significantly, the agreement makes that role formal, besides fixing accountability.
This may well turn out to be as landmark an agreement as that signed by the government and the RBI in 1994 to phase out ad hoc treasury bills, paving the way for putting an end to automatic monetisation. But the monetary policy agreement on targeting inflation comes at a time when the record of successive governments, especially at the Centre, on fiscal prudence has been below par. Overseas, the reputational risks of such failures are high but that does not appear to be the case in India, casting doubts on the new arrangement and its accountability mechanisms.
The RBI may often be too conservative for the liking of the finance ministry but the government needs to tread carefully to ensure that the fine balance between its fiscal policy arm and the central bank is not altered significantly. Arguably, electoral cycles may impinge on decisions taken by governments in the growth versus price stability debate and a non-political institution like the RBI could be better positioned to carry out the mandate to tackle inflation. This makes it more incumbent on the government to be fiscally disciplined and to be mindful and sensitive to the role of the institution and to provide it the freedom and flexibility to achieve the mandated inflation target. That should also include a say for the governor in the composition of the monetary policy committee. Else, it will be seen as an attempt to clip the wings of a central bank whose institutional record has been, by and large, stellar.
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