The ministry of finance and the Reserve Bank of India are reportedly discussing a move towards a modern monetary policy framework. This inflation-targeting framework is proposed to be effected through an agreement between the ministry and the RBI, drawing substantially from the recommendations of the Urjit Patel committee report as well as the Financial Sector Legislative Reforms Commission. Two crucial facets of this new architecture are an inflation-targeting central bank and a monetary policy committee (MPC) that will decide the policy rate, the instrument used by the RBI for achieving the inflation target. India’s move towards an MPC regime is in line with international best practice. Under the present framework, the RBI is responsible for setting its own target. This raises some concerns. The proposed framework reportedly entrusts the job of setting the policy rate to an MPC, which will ensure a multiplicity of views and promote transparent and accountable policymaking.
The RBI’s move towards inflation targeting has gained momentum since Governor Raghuram Rajan took over, but the problem of the inflation-growth trade-off was long waiting to be addressed. Calibrating this trade-off is a legitimate function of the elected representatives of the country. Low and stable inflation is in the best interests of the country, and has been recognised as being important for sustained growth, while high inflation has negative consequences for elected governments. There is, therefore, a legitimate political role in setting a clear inflation target. The previous government stressed the need for an emphasis on both growth and inflation, while the RBI has been historically apprehensive of involving the government in deciding the rate of inflation. Many of the apprehensions can be allayed by a monetary policy agreement that clarifies the principal-agent relationship between the Central government and the RBI. If the Central government sets out the inflation target in a publicly available agreement with the central bank, it will insulate inflation targeting from political volatility, while promoting a clarity of objectives for the RBI.
The last government faced flak for policy paralysis and damaging its working relationship with the RBI. Moving to the new framework will lead to a more certain monetary policy environment, which will anchor inflationary expectations and gradually lead to a more stable investment climate in India.