The cat is finally out of the bag with the announcement of Dr Urjit Patel as the next RBI governor, who will step into Raghuram Rajan’s shoes, come September. If anything, the move is likely to please markets, as it assures continuity of Rajan’s policies, at least on the inflation front. It was Patel who had proposed a new framework for monetary policy – flexible inflation targeting---in 2014, which, later in concurrence with Finance Ministry was put in place. Given that the Centre only recently announced its intention to stick with the 4 per cent CPI inflation target for the next five years, it is unlikely that the monetary policy framework will undergo major structural changes.
More consistency
Dr Urjit Patel's ground-breaking report published in 2014, has helped India adopt an inflation targeting framework which is in line with global practices. There is a convergence of views in both developed and developing economies that price stability has to be the main objective of monetary policy.
Inflation targeting, as a policy tool is more than two decades old and there is very little debate on its advantages. It clearly provides the central bank an explicit mandate to pursue price stability as the primary monetary policy objective. It has been very evident that since the adopting of this framework, there has been a greater degree of consistency in monetary policy making which is comforting.
The appointment of Patel as the RBI governor will no doubt bring cheer to both global and domestic investors, as it indicates continued focus on reigning in inflation and predictability in future monetary policy decisions.
According to a handbook published by the Bank of England — State of the Art of Inflation Targeting-2012, 27 central banks have adopted inflation targeting as their monetary policy framework.
The consensus is that above 3-4 per cent levels, inflation is a cause for concern. All of this indicates that the monetary policy framework set in India -- CPI-based inflation target of 4 per cent (+-2 per cent) band over the medium term -- is in sync with that in most other countries.
Over to the MPC
While Patel’s appointment will ensure seamless continuity of policy decisions to some extent, much now rests on the Monetary Policy Committee (MPC), which will most likely decide the next policy action come October. The panel will consist of 6 members---three from the RBI and three from the Government.
The new MPC will decide on monetary policy by a majority vote. And if there’s a tie, the RBI governor gets the deciding vote. In most inflation targeting countries decision on policy rates is based on a majority vote, steered by a committee.
But very few countries have government representation on the decision-making committee. With India Inc. and the Centre long clamouring for rate cuts to spur growth, it needs to be seen if the MPC -- under the new RBI governor Urjit Patel -- will be tempted to favour growth, while allowing itself some leeway on meeting the inflation target in the near-term.
Unfinished business?
But Dr Urjit Patel is not only known for his work on inflation targeting. His report had, at length, also sought to resolve the issue of transmission of policy rates. To start with he had suggested reducing the dependence of banks on the repo window at a single rate by capping the amount they could borrow under it. Instead the shortfall was made good by term repo auctions (introduced in Oct 2013). Hence, instead of providing these funds at a fixed rate, the RBI auctioned off the funds, with banks bidding for the rates at which they would borrow.
The idea was to tweak the amount of funds (liquidity) that it provides to banks at each auction, thereby fine-tuning short term interest rates to its requirements. The proposal was also to create a possible a yield curve across various maturities which could act as a benchmark for various money market instruments. This could have helped the RBI to maintain a stricter vigil on how banks price their deposits and lending rates across various tenors.
But term repos have not been very successful, in achieving all these objectives. It continues to remain a refinance window, as there is lack of ample liquidity in this market.
The RBI’s April policy – a move from a deficit regime to a neutral regime -- has brought the focus back on overnight rate. It needs to be seen, if Patel, after taking charge, will once again try to bring the focus back on some of his proposals, to iron out the prevailing issues in transmission of policy rates.