Mumbai, Jan. 21: The Reserve Bank governor will soon lose his sole authority over the conduct of monetary policy.
The Urjit Patel committee today submitted its long-awaited report that suggested that the decision making should be vested in a monetary policy committee (MPC) — breaking with an 80-year-old tradition at Mint Road.
Most central banks in the developed economies such as the US, the UK and Germany conduct monetary policy through consensus and/or majority voting.
The 130-page report, prepared by an eight-member committee headed by the deputy governor of the RBI, said that inflation should be the nominal anchor for the monetary policy framework — meaning that inflation targeting should be set as the predominant objective of the RBI’s monetary policy.
In line with the new thinking within the RBI, the committee said the RBI should adopt the new CPI (combined) as the measure of the nominal anchor for policy communication. The nominal anchor should be defined in terms of the headline CPI inflation, which closely reflects the cost of living and influences inflation expectations relative to other available metrics.
The Patel committee said that the nominal anchor or the target for inflation should be set at 4 per cent with a band of +/- 2 per cent around it.
The amplitude of 2 per cent from a base of 4 per cent was suggested because of two reasons: first, the vulnerability of the Indian economy to supply/external shocks and the relatively large weight of food in the CPI; and, second, the need to avoid a deflation bias in the conduct of monetary policy.
“The nominal anchor should be communicated without ambiguity, so as to ensure a monetary policy regime shift away from the current approach to one that is centered around the nominal anchor,” the report said.
While recommending the formation of a monetary policy committee, the report broadly accepted the suggestion made by Justice (retd) B.N. Srikrishna who headed the financial sector legislative reforms commission (FSLRC).
However, it deviated from the Srikrishna panel’s suggestion of a seven-member MPC with two RBI members, five external members and one non-voting finance ministry representative.
According to the Urjit Patel committee report, the RBI governor will be the chairman of the MPC, the deputy governor in charge of monetary policy will be the vice-chairman and the executive director in charge of monetary policy will be a member.
Two other members will be external, to be decided by the chairman and vice-chairman on the basis of demonstrated expertise and experience in monetary economics, macroeconomics, central banking, financial markets, public finance and related areas.
The external members will be full time with access to information/analysis generated within the Reserve Bank and cannot hold any office of profit, or undertake any activity that is seen as amounting to conflict of interest with the working of the MPC. The term of office of the MPC will ordinarily be three years, without prospect of renewal.
Each member of the MPC will have one vote with the outcome determined by majority voting, which has to be exercised without abstaining.
Minutes of the proceedings of the MPC will be released with a lag of two weeks from the date of the meeting. The MPC will ordinarily meet once every two months, although it should retain the discretion to meet and recommend policy decisions outside the policy review.
The MPC will be made accountable for failure to establish and achieve the nominal anchor. Failure is defined as the inability to achieve the inflation target of 4 per cent (+/- 2 per cent) for three successive quarters. Such failure will require the MPC to issue a public statement, signed by each member, stating the reasons for failure, remedial actions proposed and the likely period of time over which inflation will return to the centre of the inflation target zone.
The RBI will also place a bi-annual inflation report in the public domain.
The report said this target should be set in the frame of a two-year horizon that is consistent with the need to balance the output costs of disinflation against the speed of entrenchment of credibility in policy commitment.
The committee said the transition path to the target zone should be graduated to bringing down inflation from the current level of 10 per cent to 8 per cent over a period not exceeding the next 12 months and to 6 per cent over a period not exceeding the next 24 months before formally adopting the recommended target of 4 per cent inflation with a band of +/- 2 per cent.
The report also said the view that this transition path should be clearly communicated to the public.
Since food and fuel account for more than 57 per cent of the CPI on which the direct influence of monetary policy is limited, the commitment to the nominal anchor would need to be demonstrated by timely monetary policy response to risks from second round effects and infl ation expectations in response to shocks to food and fuel.
This is the first time that an explicit inflation target is being built into the framework for the conduct of monetary policy. Until now, the RBI has always said that the principle objective of monetary policy is to keep inflation down to a desired level. The RBI has said in the past that it is comfortable with an inflation rate of around 5 per cent.
The committee has brought the base objective level a notch lower to 4 per cent but cushioned it with an acceptable oscillation of 2 per cent on either side.
At the same time, the committee said that consistent with the Fiscal Responsibility and
Budget Management (Amendment) Rules, 2013, the Centre needs to ensure that its fiscal
deficit as a ratio to GDP is brought down to 3.0 per cent by 2016-17.