Millennium Post

RBI must look after depositors

If the recommendations of the Urjit Patel Committee on monetary policy-making are adopted in full, the governor of the Reserve Bank of India, and the members of the freshly recommended monetary policy committee, might have to face repeated public embarrassment.

The Committee suggested formation of a monetary policy committee will have RBI governor as chairman and the deputy governor in charge of monetary policy formulation as vice chairman. The executive director of RBI in charge of monetary policy will also be a member of this committee. Two others will be taken from outside.

The thing is that if inflation continues to remain above the target rate of four per cent (+/-2 per cent) for three quarters all of them have to give a signed statement in public why inflation targeting has failed and when that should get corrected. That is fine: admission of failure in high places is welcome. The committee by trying to replicate the processes through which monetary policy is formulated in developed economies like US or UK, is seeking to introduce elements and approach which might not be suitable for India. The panel recommendations attempt to bring monetary policy making into an iron straightjacket and give very little play to judgment. The approach suggested will make monetary policy rigid and linear.

This will insulate monetary making from ground reality and from the imperatives of growth in a developing economy. Look at some of the implications of what the committee has suggested. The committee suggests that RBI’s policy rate should always be positive. But the committee is concerned only with the lenders. What about depositors who are putting their money into banks. Almost never this is considered by the RBI. At any rate, what is the consequence of this recommendation?

In the current context, this should mean the central bank should raise rate by around two per cent in its policy meet later this month, given the fact that CPI inflation is around 10 per cent and repo rate is at 7.75 per cent.  At a 10 per cent policy rate, the borrowers should pay at least a minimum of 12 per cent interest rate. In most cases, lending rates should be at around 14 per cent.

Admittedly, monetary policy is about lending rates. But then if lending rates go up and banks earn much higher, on whose money do they earn.

Depositors should also get some of that bounty rather than eight per cent as at present, if not less. Will RBI be willing to witness such readjustments of lending and deposit rates? The panel has recommended inflation target of four per cent, plus/minus a two per cent band. Current level is way ahead and the committee suggested a phased reduction of inflation to eight per cent in the next 12 months, six per cent in next 24 months and four per cent band thereafter.

However, given the structural nature of Indian inflation with food prices rising for the better part of last three years, a monetary policy regime suggested in the framework of the Urjit Patel committee would be too harsh for growth. It would be too simplistic to expect that the food prices could be contained with policy rate at 10 per cent-plus. Why then, was interest rate not raised by Governor Raghuram Rajan last time. Could be that he was taking note of the falling food prices in December and hoping that this should moderate in the medium term, even though the absolute CPI rise was close to double digit figure. Taking advantage of the small window of falling prices, he could have been seeking to give growth a little more support, particularly in view of the fact that industrial growth was down for a long time. Patel committee’s approach of inflation targeting as the fundamental objective of monetary policy has, willy-nilly, the assumption that all prices are free and not within government control. Food prices, for example, have two factors which are certainly under strict government control and which determine the course of food prices.

First, the government sets the MSP for a wide range of farm products every year and these are revised upwards. How do you control their incidence by interest rate policy. Secondly, as is public knowledge and been pointed out by the present governor, farm products movements are controlled by state governments.

Surely, you cannot have a Federal Reserve system and norms for monetary policy making when you do not have flexibility in prices as in that country. There is a positive aspect that implementation of such norms based formulation of monetary policy should make it much more predictable and transparent. The question is predictability at what cost? These implication should be carefully examined before the recommendations are adopted.

The recommendations of the Urjit Patel committee on monetary policy-making in India should be carefully examined before being implemented.

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