The Reserve Bank of India (RBI) has set up an expert committee under Urjit Patel to revise and strengthen the monetary policy framework. Inter alia , the terms of reference include a review of the nominal anchor and instruments.

The scope of the work of the expert body is so comprehensive that it is comparable to the Chakravarty Committee on the working of the monetary system, the report of which was published in 1985.

Certainly it helps in policy making to have an anchor that focuses on the goal to be attained.

Among the various anchors, it is generally the concept of inflation targeting that has been adopted in many developing and developed countries with varying measures of success. It can be reviewed keeping in mind the Indian conditions.

It is not as if we do not have an inflation target. There is a formal declaration in the RBI’s periodical reviews of the objective of keeping the rate around 5 per cent.

There is also a statement that the medium-term target would be 3 per cent. It passes one’s comprehension as to how the medium-term objective of 3 per cent can be achieved if the annual rate is mentioned as 5 per cent or more year after year.

Inflation targeting would only mean that the objective would be written into law, unlike now, resulting in certain consequences, if it is not realised.

The success of targeting would very much depend on the autonomy of the central bank in pursuing its goal and government’s control of fiscal and current account deficits. Experience in many other countries shows that inflation targeting is best introduced when it is low, which is not the case in India now.

Some reluctance One important question is whether the target should be related to the Wholesale Price Index (WPI) or the Consumer Price Index (CPI).

The advantages and appropriateness of the latter have been written about. But there is still some reluctance on the part of the RBI to go the whole hog in shifting to CPI.

It is one of the reasons why it lacks credibility in its inflation forecasts as revealed in the surveys of expectations of consumers.

It should remember that it makes policy for the common man and not for the wholesale merchant.

While Producers’ Price Index would be meaningful in studying its transmission to the CPI, the WPI has turned out to be no good guide as revealed in the widening differences between wholesale and retail price inflation. The reason for not adopting the CPI officially is that its compilation is not yet stabilised. The revised series has been in position since January 2011.

How many more years would it take for the series to stabilise? Have the other indices on the economy stabilised despite being compiled for a longer period? Substantial revisions are made therein after two months that do not attract attention. Another anomaly is the concept of core inflation that excludes food and energy prices. It is in use in the US where only urban prices are measured, the rural population being insignificant. I have written about the irrelevance of this concept under Indian conditions.

After a long time, the RBI was persuaded to refrain from referring to it from its policy statements. Instead it used a more neutral term, namely, ‘non-food manufactured products inflation’.

To my horror, in some recent official pronouncements, ‘core inflation’ has raised its ugly head once again — this time in CPI! Maybe it is because it is easy to pronounce unlike the mouth-full ‘non-food manufactured products inflation’! The whole CPI should be treated as core inflation.

Exchange Rate An important consideration for setting up an anchor is the role of the exchange rate. When the RBI Act was passed in 1934, economic science was not as developed as it is now. Econometrics and mathematical economics got a boost after the unfolding of Keynesian economics that led to the emergence of macroeconomics.

So there was no recognition at that time of such ideas as the impossible trinity.

Now with all the theoretical and empirical knowledge we have, should we still say that stability in both domestic prices and exchange rates, which was perhaps implied in ‘monetary stability’, are attainable simultaneously through policy making?

Domestic price stability should have a priority over exchange rate, if there is a conflict.

Operating Procedures So far as operating procedures are concerned, a thorough review of the Liquidity Adjustment Facility needs to be undertaken.

After it was pointed out many times that the repo to tide over temporary liquidity problem had become either a refinance facility to banks with excess SLR securities to carry on their normal business or an avenue for arbitrage opportunities or a source of speculation in forex markets, the RBI used the stick curtailing the access.

The Patel Committee should think about restraints on the use of repo remembering that it is meant to help banks with shortage of liquidity.

There should be an ex-post verification of the end-use of heavy repo operations by the same bank day after day over a long period.

In this connection, the RBI should consider the possibility of conducting open market operations a la the Federal Reserve System to keep the call money rates within a narrow range of its policy rates.

(The author is a Mumbai-based economic consultant.)

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