Ministry disagrees with RBI policy paper

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CPI incorrect measure to tame inflation: Mayaram

Ministry disagrees with RBI policy paper
An RBI panel’s sweeping proposals for an overhaul of the monetary policy, including using consumer price inflation for setting long-term inflation targets, has not found favour with the finance ministry. The ministry feels the proposals are premature.

Critics in the ministry say the recommendations are only “aspirational” as retail inflation data collection is still imperfect in the country. Some describe the recommendations of the panel, headed by RBI deputy governor Urjit Patel, as bold. But, clearly, the proposals have taken the government by surprise.

The panel set up in September to revise and strengthen the monetary policy framework have the potential to change the relations between the government and RBI for ever, experts and brokerages say.

The recommendations are seen by some as coming at an inappropriate time, considering the slowdown in growth and high inflation, particularly in retail food prices.

“The consumer price index (CPI) has a lot of imperfections. It requires a whole lot of sophistication, which we have not achieved yet on determining it... So it is, in my opinion, a little premature to consider CPI as the anchor of our inflation target,” economic affairs secretary Arvind Mayaram, now attending the World Economic Forum meeting at Davos, said on Wednesday.

“There are other structural issues that need to be addressed if we need to control food inflation... Even if inflation is higher, it does not mean that people will start eating less just because the interest rates are higher,” Mayaram said, implying that food inflation is inelastic.

Only recently CPI underwent some improvement, but that is not enough. The current method of measuring CPI was started in 2012. The new series required a lot of improvement, including in the basket of goods and their weights.

The panel has recommended that RBI should bring down CPI or retail inflation to 8 per cent over the next 12 months and to 6 per cent over 24 months. The proposal that’s more daring is to set a long-term inflation target of 4 per cent, with room of deviation of 2 per cent in either direction.

“CPI has a very large element of food. We know food inflation cannot be curbed purely through monetary policy… So, there are other structural issues that need to be addressed if we need to control food inflation,” Mayaram said.

“In India it may be difficult to do that kind of (inflation) targeting… We don’t have yet achieved that level of stability in prices where we can curb certain volatilities or volatility in certain periods through very specific targeting,” he said.

However, Mayaram added, it was important to keep inflation under control with all necessary steps. Lately, retail inflation slowed; in December it was at a three-month low of 9.87 per cent. The RBI panel’s proposal is aimed at bringing western-style rigour to our economy. But the Indian economy suffers from problems associated with a developing country and these include supply bottlenecks, an unpredictable monsoon and the politically sensitive subsidy issue.

It has also proposed that monetary policy will be decision by a committee. Decisions are now made by the governor — in line with the practice at major central banks, including the US Federal Reserve.

The report led to a hardening of yields in government securities by at least 15 to 20 basis points on Wednesday. The 10-year benchmark security closed at Rs 101.43, implying an yield of 8.61 per cent.

HDFC Securities said in a report, “If RBI were to accept this in toto, it would forever change the relationship between Mint Street and North Block. It will make RBI more independent.”

Crisil said interest rates would remain firm if RBI accepted the recommendation. The committee also advocated that the real policy rate should be positive, implying that the repo rate, currently at 7.75 per cent, should be higher than consumer price inflation expected to average around 8.5 per cent in 2014-15. “In other words, there is little scope for monetary policy to boost growth in 2014-15. Any recovery in investments, therefore, will be largely driven by clearance of stalled projects,” Crisil added.

Bank of America Merrill Lynch said, “The operating rate will gradually shift to the 14-day repo rate from the overnight call rate. RBI will continue to manage liquidity and meet the demand for liquidity from the banking system using a mix of term repos, overnight repos, OMOs and the MSF. On balance, we see RBI’s shift to inflation targeting as a step in the right direction. The time span over which it can be achieved will vary according to a number of factors, such as the rains or the global growth cycle or oil prices.”

Economists say the multiple indicator approach is not working in India and needs to be changed with accountability on the numbers released. Nomura Securities said, “Headline CPI inflation should be the nominal anchor for monetary policy.”

Siddhartha Sanyal, an economist at Barclays, said the committee made several key recommendations. If adopted, they would represent a paradigm shift in India’s monetary policy tools and framework.”


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