A strategic monetary policy framework
8 April 2015 5:41 AM IST
On the face of it, the Reserve Bank of India’s policy announcement, keeping all major parameters unchanged, might appear deadpan. Apparent reactions to the policy have also been along that line. Given the current trends in inflation and production growth in industry and services sectors, such a stance may seem appropriate. This policy statement has several important aspects which should be noted for a better understanding of the central bank’s overall bearing, not just for now but in the future.
The first thing to remember is that it is for the first time that RBI is presenting a monetary policy framework after its agreement with the government over inflation targeting and interest rate setting.
The agreement between the Centre and RBI, concluded in February this year, will look to contain consumer price inflation within 6% by January 2016 and within 4% with a band of 2 percentage points for all subsequent years. This has to be a durable inflation level for the economy and hence the RBI and government have to work towards achieving that target together. While elaborating on its parameters for setting monetary policy actions, RBI has mentioned several factors.
RBI is anchoring its policy to the progress made in government policies and implementation of the same on a variety of fronts from “unclogging” supplies of key inputs like power and land, faster clearance and implementation of stalled projects to cutting down subsidies. This is possibly central bank’s answer to the government setting inflation targets.
These are surely very important macro-economic targets for the government. But linking monetary policy directly to such broader goals every time could possibly make the process too diffusive. After all, the central bank’s monetary policy is often a short term response to developing situation. Many of these stated parameters are more of medium or operational issues. Making monetary policy formulation contingent upon faster clearance of stalled infrastructure projects could defeat the purpose of monetary policy itself.
Similarly, if the central bank formulates monetary policy, taking note of land as a key factor of production and ensuring its supply, it might drive the central bank to the realm of political wrangling. Should monetary policy kept stringent if opposition blocks passage of the land bill? What will happen if mining sector is bogged down by lack of clearances? A whole lot of questions will possibly crop up if the central bank has to take note of such diverse factors.
Secondly, on price dynamics in the economy, the Reserve Bank is appearing to be getting into disaggregated price trends at too micro levels. While previously, wholesale price index was the broad measure of inflation, RBI has now moved over to consumer price index. Now, RBI appears to be tracking the sectoral and sub-sectoral price trends.
The central bank is sticking to monitoring the sectoral prices in formulating its policy. In view of the falling prices of some goods, it will take into account the disinflation trends as well. Admittedly, looking at the price trends of select sectors is important. We have been witnessing a clear dichotomy in this area for some time now. While, the prices of food articles have been merrily rising, those for manufactured products were stable or sometimes falling. In fact, even the WPI and CPI were going different ways; with WPI falling for several months when CPI was on the rise, mainly because of growing food prices.
On the one hand if sectoral prices are becoming very important, then a long-gathering fall in manufactured goods prices should warrant a more accommodative policy stance. On the other hand, for some food articles inflation is still high, as the policy statement mentions, such as, protein rich foods. What will the RBI’s price evaluation framework weigh on? Will it be based on disaggregated food articles prices or the sharp disinflationary trends in manufactured goods prices?
Once again, judgment and evaluation of the overall situation should be the real guide to action than mere technical pointers and indicators. Thirdly, it appears as though Reserve Bank has taken advantage this time to address some medium and longer term developments in the banking and financial sector.
The first area appears to be the transmission of RBI policy initiatives. RBI has lowered policy rates twice recently. The banks, however, have maintained the same lending rates. If transmission does not take place, where is the fun in policy making? Towards this end, RBI is setting a time bound programme to shift over to a marginal cost of funds-based determination of their base rates.
In this respect, RBI is seeking to give priority to the system of independent financial benchmarking. A new company set up by three industry associations in financial services should start functioning by the end of May and their indices are hoped to be used by banks for pricing their products. This approach should bring uniformity among banks practices in pricing their products.
These steps are important for future setting of monetary policy as the central bank noted that accommodative policy moves have not been implemented by banks so far. Future monetary actions will first of all depend on how far the policy changes have been transmitted.
RBI has also taken a few critical regulatory moves and initiatives for strengthening the financial and banking system. These should help our banks grow in the future. IPA
The first thing to remember is that it is for the first time that RBI is presenting a monetary policy framework after its agreement with the government over inflation targeting and interest rate setting.
The agreement between the Centre and RBI, concluded in February this year, will look to contain consumer price inflation within 6% by January 2016 and within 4% with a band of 2 percentage points for all subsequent years. This has to be a durable inflation level for the economy and hence the RBI and government have to work towards achieving that target together. While elaborating on its parameters for setting monetary policy actions, RBI has mentioned several factors.
RBI is anchoring its policy to the progress made in government policies and implementation of the same on a variety of fronts from “unclogging” supplies of key inputs like power and land, faster clearance and implementation of stalled projects to cutting down subsidies. This is possibly central bank’s answer to the government setting inflation targets.
These are surely very important macro-economic targets for the government. But linking monetary policy directly to such broader goals every time could possibly make the process too diffusive. After all, the central bank’s monetary policy is often a short term response to developing situation. Many of these stated parameters are more of medium or operational issues. Making monetary policy formulation contingent upon faster clearance of stalled infrastructure projects could defeat the purpose of monetary policy itself.
Similarly, if the central bank formulates monetary policy, taking note of land as a key factor of production and ensuring its supply, it might drive the central bank to the realm of political wrangling. Should monetary policy kept stringent if opposition blocks passage of the land bill? What will happen if mining sector is bogged down by lack of clearances? A whole lot of questions will possibly crop up if the central bank has to take note of such diverse factors.
Secondly, on price dynamics in the economy, the Reserve Bank is appearing to be getting into disaggregated price trends at too micro levels. While previously, wholesale price index was the broad measure of inflation, RBI has now moved over to consumer price index. Now, RBI appears to be tracking the sectoral and sub-sectoral price trends.
The central bank is sticking to monitoring the sectoral prices in formulating its policy. In view of the falling prices of some goods, it will take into account the disinflation trends as well. Admittedly, looking at the price trends of select sectors is important. We have been witnessing a clear dichotomy in this area for some time now. While, the prices of food articles have been merrily rising, those for manufactured products were stable or sometimes falling. In fact, even the WPI and CPI were going different ways; with WPI falling for several months when CPI was on the rise, mainly because of growing food prices.
On the one hand if sectoral prices are becoming very important, then a long-gathering fall in manufactured goods prices should warrant a more accommodative policy stance. On the other hand, for some food articles inflation is still high, as the policy statement mentions, such as, protein rich foods. What will the RBI’s price evaluation framework weigh on? Will it be based on disaggregated food articles prices or the sharp disinflationary trends in manufactured goods prices?
Once again, judgment and evaluation of the overall situation should be the real guide to action than mere technical pointers and indicators. Thirdly, it appears as though Reserve Bank has taken advantage this time to address some medium and longer term developments in the banking and financial sector.
The first area appears to be the transmission of RBI policy initiatives. RBI has lowered policy rates twice recently. The banks, however, have maintained the same lending rates. If transmission does not take place, where is the fun in policy making? Towards this end, RBI is setting a time bound programme to shift over to a marginal cost of funds-based determination of their base rates.
In this respect, RBI is seeking to give priority to the system of independent financial benchmarking. A new company set up by three industry associations in financial services should start functioning by the end of May and their indices are hoped to be used by banks for pricing their products. This approach should bring uniformity among banks practices in pricing their products.
These steps are important for future setting of monetary policy as the central bank noted that accommodative policy moves have not been implemented by banks so far. Future monetary actions will first of all depend on how far the policy changes have been transmitted.
RBI has also taken a few critical regulatory moves and initiatives for strengthening the financial and banking system. These should help our banks grow in the future. IPA
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