Why RBI alone can't achieve price stability

Inflation targeting has been made the central focus of monetary policy by outgoing Reserve Bank of India (RBI) governor Raghuram Rajan, who will be remembered long after he leaves next month.

The Centre has given statutory backing to inflation targeting, requiring the RBI governor to explain to the government if the bank misses its inflation targets for three consecutive quarters.

A notification was issued by the government on August 6 on monetary policy. The Urjit Patel Committee, set up by Rajan, suggested setting inflation targets and accountability on the RBI.

A Monetary Policy Committee (MPC) has been proposed consisting of three members from the RBI, including the governor, and three others to be appointed by the government.

However, ultimate control is believed to rest with the RBI regarding declaration of rates. The constituents of the MPC will set the inflation target as well as explain for any slippage in the future.

With inflation targeting on focus by the government, at 4 per cent with a band of 2 per cent points on either side for five years ending 2021, PM Narendra Modi's government has clearly expressed its commitment to macroeconomic stability in the long run.

Economic experts the world over, with this move by India, now consider it to have gained entry into the elite club of top world economies.

The American press has been highly appreciative of India's recent fiscal and monetary policy reform measures.

Although successive RBI governors did talk about it, it is Rajan who tied the government and the RBI into a legal knot. Let us hope and pray this union lasts.

Now that the numerical target for inflation has been set, the interest rate setting structure, much debated by all, has been put on autopilot mode for the next five years.

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Of course, the MPC has to conduct some exercise in judging the momentum of interest rates rather than the RBI governor being on the watch alone, after fixing the rate, both by himself.

But the most vital point here is, the calibre and experience of the members of the committee will henceforth decide the monetary policy and its course.

Now that it is mandated that the repo rate be above inflation rates as measured by the Consumer Price Index (CPI), economists opine that policymakers have committed themselves to this rate for a minimum period of two-three years.

India's retail inflation as measured by the CPI touched a 22-month high of 5.77 per cent in June this year.

These numbers are highly volatile because 'food and fuels' accounts for more than half or of its weightage and three-fourths of spending by the majority of Indian households is on food and some of it is on fuel.

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The RBI aims at 5 per cent inflation by January next year and 4 per cent by May 2018.

If at all rates ease, it has to be through liquidity.

The targets have been set roughly for a period of five years. So there is absolutely no question of interest rates declining from the current levels as the entire transmission of policy rates will now have to be managed only through liquidity in the market.

The government should not expect any rate movement from the RBI at least till the end of this government's term. It is good that a robust monetary policy has been put in place.

The only expectation of the people is that the RBI and government should walk in step and walk the talk all the way.