With govt getting a say, RBI’s inflation fighting will never be the same

The Reserve Bank of India’s (RBI) monetary policy, as we see it today, and the customary war-cries that often accompany central bank’s announcements, wouldn’t follow the same pattern any longer. The clue lies in one of the less-discussed lines in Arun Jaitley’s budget speech on Saturday. “To ensure that our victory over inflation is institutionalized and hence continues, we have concluded a Monetary Policy Framework Agreement with the RBI, as I had promised in my Budget Speech for 2014-15. This Framework clearly states the objective of keeping inflation below 6 per cent,” Jaitley said. [caption id=“attachment_2130891” align=“alignleft” width=“380”]  Reuters[/caption] The RBI and government have been discussing the new monetary policy framework for a while now. With both signing an agreement, it has now become a reality . The new monetary policy committee, which will set the inflation target from now on, will have eight members, including a finance ministry nominee and external members. The RBI governor will head the panel. As Jaitley said, the government is likely to soon move to amend the RBI Act this year to provide the agreement a legislative backing. If one goes by the comments of finance ministry officials, the government already has its inflation targets in mind. It wants to achieve 4 percent retail inflation by fiscal year 2017. To be sure, these numbers conform to the targets set by the central bank’s own expert panel under Urjit Patel, which has a 6 percent target by next January. The new framework, which is official now and is likely to be made constitutionally recognised during the course of financial year 2016, will have the following positive/ negative consequences on the central bank. First, on the positive side, under this new framework, the RBI will likely escape from the customary mud-slinging from the finance ministry and the words of discontent from politicians, every time it raises the interest rate to contain inflation. This is because the RBI will have the liberty to fearlessly work towards achieving the inflation target, jointly set between the central bank and the government. If that requires increasing rates as warranted by the macro-economic situation, it can do so with the backing of the government. In the past during the UPA rule, there have been instances when finance ministers practically announced the policy, hours before RBI did so. There were also instances when finance ministers took on the central bank’s decisions publicly saying the ‘the government will walk alone” its path to revive growth, if required. Such open contradictions are likely to be avoided in the new scenario. Second, the negative side: As Firstpost highlighted on the budget day , the new frame work will cut the RBI to size by limiting its powers to formulate the monetary policy on its own depending on its own logics and reasons. The government will have a significant say in setting the desired targets for inflation and its view will likely be influenced depending upon which side of the growth-inflation trade-off the priority rests for the party in power. Governments, which have to take care of political/public interests and sometimes coalition pressures (fortunately absent in the current scenario), tends to weigh growth concerns over inflation, on which it doesn’t have much control anyway. Unlike the central bank, for which only economic prudence matters, the government’s views will also get influenced by political priorities, which can put both the North block and the Mint street on a collision course. To be sure, the RBI governor will have the veto power in the new monetary policy framework. But, one has to wait and watch how much this power works in its favour, given that the finance ministry, technically, is the boss of the central bank. The RBI’s powers will further be diluted when the debt management — one of the core functions of the RBI at present and something that has critical importance in the liquidity management in the banking system — will be moved to a separate debt management agency, as envisaged in the budget. That said, how the new set up will evolve ultimately is something only time will tell. But, for sure, 2015-16 will see changes of historic significance in the way Indian central bank operates.