‘Anticipatory’ Monetary Policy – India's New Beginning

The Modi government has silenced many of the critics who speculated that it would fill the Monetary Policy Committee with such nominees who, in the hour of need, would bid for it, by appointing Chetan Ghate, Professor, Indian Statistical Institute; Pami Dua, Director, Delhi School of Economics; and Ravindra Dholakia, Professor, Indian Institute of Management, Ahemadabad.

Interestingly, the members appointed bring with them diverse views to the committee: Ghate, who incidentally served as a member of the Urjit Patel Committee on the monetary policy framework, is a known inflation crusader; Pami Dua, who arguing in one of her papers, “Unsterilized forex market intervention can result in inflation, loss of competitiveness and attenuation of monetary control … therefore it is essential that the monetary authorities take measures to offset the impact of such foreign exchange market intervention”, makes her belief that RBI must stay focused on inflation management abundantly clear; while the third member, Dholakia, who arguing that the “RBI governor’s assertion on no serious trade-off existing between inflation and growth in the country does not get any support from recent empirical evidence” and “deliberate disinflation would impose sizeable immediate cost of loss of output on the system”, perhaps exhibits his preference for controlling inflation by raising output rather than the cost of funds.

With the MPC consisting of three representatives from the RBI, viz., Urjit Patel, Governor, RBI, R Gandhi, Deputy Governor, RBI, and Michael Patra, Executive Director, RBI, and three nominated members from the government, being in place, India is all set to say goodbye to the practice of the RBI governor solely deciding interest rates all by himself and make a new beginning: henceforth, the MPC will fix up interest rates based upon their deliberations on the likely macroeconomic scenario of the country in the coming 12-18 months.

This new system is certain to pose quite a few challenges: One, under the new system, policy makers no longer react to the inflation prevailing in the country, but make policy decisions based on the forecasts regarding what is likely to happen in the future—formulate a kind of ‘anticipatory’ monetary policy; two, it means heavy reliance on forecasts—as to what is likely to happen to the global economy, what will happen to rupee, what will happen to global interest rates and how will all these cumulatively impact inflation—but formulating a policy based on the interpretation of these forecasts for achieving the targeted inflation rate of say, 6% or 7% is in itself a big challenge; three, the members of the committee are supposed to record the factors that have driven them to vote for a particular choice that will ultimately be made available for public scrutiny and this communication is a no simple challenge, and fourth but the most important one is, “how good are our forecasts that are made out of poor data, that too, pertaining to an economy that is largely non-monetized and agrarian to base policy formulations?” Even the former RBI governor, Dr Subbarao lamented about poor dependability of our data and hence, it is the answer to this question that decides the success of the very inflation targeting.

In a country where mere dissent is often perceived as enmity, it is to be seen how the committee members deliberate openly and air a voice of dissent wherever necessary to ensure that the policy rate setting will no longer remain one man’s decision as in the past. To cap all these, there remains the ultimate question: in the era of cross-border free flow of capital and increased integration of global capital markets, how successful rate-setting based on local conditions alone would be? And also how to accomplish the twin objectives: “to maintain price stability while keeping in mind the objective of growth” that was mandated by the recent legislation of June 2016.

Nevertheless, the fact that the Chairman of MPC is none other than the very architect of the new model, it is certain to ensure that the committee will deliver on its intended objectives meaningfully.