RBI panel wants CPI to steer money policy

Tags: News

Inflation target 4%; 3% fiscal deficit by FY17

RBI panel wants CPI to steer money policy
India’s central bank may soon adopt the new consumer price index (CPI) for anchoring its money policy and lower its inflation target to 4 per cent with a band of plus or minus 2 per cent around it.

An expert panel, led by Reserve Bank of India (RBI) deputy governor Urjit Patel, on Tuesday recommended in a 130-page report that “a new combined CPI” be adopted as a measure of nominal anchor for policy communication.

RBI had set up the panel in September 2013 to revise and strengthen the monetary policy framework. It suggested that monetary policy decision making should be vested in a monetary policy committee (MPC) headed by the governor. It should have two external members.

RBI is scheduled to review its money policy on January 28 amid growing consensus that it would maintain status quo on policy rates in view of easing inflation and a contraction in manufacturing activity.

“The nominal anchor or the inflation target should be set at 4 per cent with a band of +/- 2 per cent around it in view of the vulnerability of the Indian economy to supply/external shocks and the relatively large weight of food in the CPI; and the need to avoid a deflation bias in the conduct of monetary policy,” the panel said.

It warned that given the elevated level of CPI inflation, hardened inflation expectations, supply constraints and weak output performance, “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 CPI fell to a three-month low of 9.87 per cent in December 2013.

The panel said the “recommendation is intended to better ground inflation expectations by making clear that inflation is the RBI’s primary objective and that it expects to be held accountable for its performance in this regard.”

Until recently, RBI communicated indicative inflation projections in terms of wholesale price index alone, essentially because it is the only measure of prices at the national level and CPIs have traditionally addressed prices facing specific sections of society.

“Traditionally, WPI inflation has been the key metric followed by policymakers. However, over the past four years, the rising gap between price levels implied by WPI and CPI meant that WPI inflation (akin to PPI elsewhere in the world) is not the effective measure of the underlying inflation pressures that savers are facing,” Morgan Stanley analysts Chetan Arya and Upasana Chachra said in a note.

The RBI panel said the government needs to ensure that fiscal deficit is brought down to 3 per cent of GDP by 2016-17 “consistent with the Fiscal Responsibility and Budget Management (Amendment) Rules, 2013.” Finance minister P Chidambaram aims to rein in fiscal deficit at 4.6 per cent of GDP in FY14.

The panel also suggested elimination of the administered setting of prices, wages and interest rates, as it found them to be “significant impediments to monetary policy transmission and achievement of the price stability objective.”

The report said the monetary policy committee would be held accountable for failure to establish and achieve the nominal anchor. It defined “failure” 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 reason(s) 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 report said.

The panel also suggested that dependence on market stabilisation scheme (MSS) and cash management bills (CMBs) should be phased out, after the government debt and cash management is taken over by the debt management office.

The committee recommended addition of some new instruments to the tool kit of monetary policy. It said all fixed income financial products should be treated on par with bank deposits for the purposes of taxation and TDS.

On open market operations (OMOs), it said, they have to be detached from fiscal operations and instead linked solely to liquidity management. OMOs should not be used for managing yields on government securities, it added.

Post new comment

E-mail ID will not be published
CAPTCHA
This question is for testing whether you are a human visitor and to prevent automated spam submissions.

EDITORIAL OF THE DAY

  • Amidst Sino-Indian bonhomie, the Tibet issue cannot be wished away

    Tibet did not figure in the three-day high-level meetings between India and the People’s Republic of China (PRC).

FC NEWSLETTER

Stay informed on our latest news!

INTERVIEWS

GV Nageswara Rao

MD & CEO, IDBI Federal Life

Timothy Moe

Goldman Sachs

Chander Mohan Sethi

CMD, Reckitt Benckiser India

COLUMNIST

Varun Dutt

<b>Riskfactor</b>: Intertemporal choices

Intertemporal choice is the study of the relative value people ...

Parvez Imam

Why we all have blood on our hands

What does the Jammu and Kashmir flood make us think? ...

Dharmendra Khandal

The peculiar possibilities of animal poop

You can tell a lot about an animal by its ...

INTERVIEWS

William D. Green

Chairman & CEO, Accenture