The merit of the Urjit Patel Committee Report to Review and Strengthen the Monetary Policy Framework (January 2014) is its analytical rigour and clear recommendations on improving the efficacy of monetary policy. The Patel Report would become the locus classicus on monetary policy in India.
Key Recommendations The key recommendations of the Committee are:
(i) The headline Consumer Price Index (CPI) should be the nominal anchor for monetary policy and the Reserve Bank of India (RBI) should make this the predominant objective.
(ii)The nominal anchor for inflation should be set for a two-year horizon at 4 per cent with a band of plus or minus 2 per cent. Since the present CPI inflation is 10 per cent the Committee recommends a ‘glide path’ of 8 per cent for January 2015 and 6 per cent for January 2016.
(iii) The Central Government needs to reduce the fiscal deficit to 3.0 per cent of GDP by 2016-17. Administered prices, wages and interest rates are impediments to transmission of monetary policy and should be eliminated.
(iv) Monetary policy decisions should be vested in a Monetary Policy Committee (MPC) comprising the Governor, the Deputy Governor and Executive Director in charge of monetary policy and two external full-time members. The decisions of the MPC will be by voting. Members will be accountable for failure to attain the target—failure being defined as inability to attain the target for three successive quarters.
(iv)The real policy rate should be positive. In the first phase the weighted average call rate would be the operative target and the repo rate would be the single policy rate. The funds available at the repo rate would be restricted and increasingly liquidity would be provided at the 14 day term repo; longer-term repo auctions should be introduced.
(v) In the second phase, the 14-day repo rate would be the operative target and recourse to outright two-way open market operations (OMO) would determine liquidity. OMO should not used to manage yields on government securities.
(vi)There should be a remunerated standing deposit facility at the RBI to sterilise excess liquidity.
(vii) With an independent debt management office, the market stabilisation scheme and cash management bills should be phased out.
(viii) All sector specific refinance should be phased out as committed to the Asian Development Bank in 1992.
The implications of the key recommendations are discussed below.
Nominal Anchor The CPI inflation is quite clearly the appropriate anchor. Those apprehensive of a strong and effective monetary policy will try to stall this recommendation. The RBI should unequivocally emphasise, in its policy statements, that CPI inflation would be its nominal anchor. The gliding to the 4 per cent plus or minus the CPI nominal anchor would be non-disruptive and the RBI should, continue to stress the 8 per cent CPI inflation for January 2015 and 6 per cent for January 2016.
The Patel Committee recommends a remunerated standing deposit facility which, unlike the reverse repo, would not require government securities as collateral. While this would allow sterilisation of capital inflows, without any limit it would be detrimental to the RBI balance sheet as there is no provision in the law to ensure that all losses of the RBI will be met by the government. In the absence of such a legislative clause it would be hazardous to introduce a remunerated standing deposit facility.
The structure and composition of the MPC are pre-eminently suitable. The MPC will have two external full-time members with a fixed three year non-renewable term. There could be some hierarchical problems about these members questioning executive decisions. The RBI should study the experience of Korea and other countries which have full-time members in the MPC.
The Financial Sector Legislative Reforms Commission (FSLRC), in its Report (March 2013), envisaged a MPC with two RBI members and five external members nominated by the government; besides the Finance Secretary or Secretary Economic Affairs would also be a non-voting member of the MPC. Such a structure would make the RBI into a vassal state.
There are media headlines that the Patel Committee advocates full autonomy on interest rates. If the RBI is to be accountable it should have some degree of flexibility to attain its objectives. C. Rangarajan has argued that all the autonomy the RBI needs is headroom to operate monetary policy. The RBI would do well to recall the dictum that autonomy is never given, it is earned and taken.
The anatomy of the RBI The RBI could explore the scope for converting the present Technical Advisory Committee into a five member MPC with voting by members as envisaged by the Patel Committee, with two External Members who could be members of the RBI Board. This could obviate the need for legislative changes which could take years. The Patel Committee endorses the setting up of an independent Debt Management Office (DMO), but rightly cautions that the RBI’s OMO should be strictly limited to liquidity requirements and not be a vehicle for enabling government borrowing at low interest rates.
The FSLRC recommendation that RBI should be a member of the DMO Council as also the Management Committee is flawed as the Chairman of the DMO is enjoined to obtaining unanimous decisions which would make the RBI monetary policy subservient to the DMO.
There should be an open and constructive debate and the FSLRC Report should not be treated as the holy grail. While the Report attempts to provide a legislative framework, the Patel and Mor Committees set out the policy objectives, and hence all three Reports should be examined in a co-ordinated manner.
(The writer is a Mumbai-based economist)