Will RBI replace WPI with CPI as Choice of Nominal Anchor for India’s Monetary Policy?

The Reserve Bank of India's Third Quarter Review of Monetary Policy for 2013-14 is scheduled on 28 January 2014. The committee report is created to come up with ways to make the country's monetary policy more transparent and predictable.

The RBI panel said that the central bank should make moves to lower India's consumer inflation, which has been close to 10% in recent months, to 8% within the next 12 months and to 6% in next two year, before adopting the target. This transition path should be clearly communicated to the public.

Accordingly, the Committee has recommended that Open-market operations (OMOs) have to be detached from Fiscal operations and instead linked solely to liquidity management. OMOs should not be used for managing yields on government securities.

 The Expert Committee recommended to revise the reduction in Statutory Liquid Ratio (SLR) of banks, to a level in agreement with the requirements of Liquidity Coverage Ratio (LCR) prescribed under the Basel III framework.

More frequent intra-year resets for small savings schemes and subvention (a grant of money) on interest rate for lending to certain sectors would need to be re-visited.

Right now in India monetary policy decisions are made by the RBI governor alone, though he gets input from an advisory committee. The panel suggested monetary policy to be decided by a committee headed by the governor with final decisions through a vote of the committee members, as is the practice in some developed countries like the UK.

Each Monetary Policy Committee (MPC) member will have one vote and the outcome of any issue will be determined by a majority in voting, which will have to be exercised, without abstaining.

MPC should meet once every two months to issue statement if CPI fails to hit target. The RBI will also placed a bi-annual inflation report in the public domain, drawing on the experience gained with the publication of the document on macroeconomic and monetary developments.

To support the operating framework, the Committee recommends that some new instruments be added to the toolkit of monetary policy. Firstly, to provide a floor for the new operating framework for absorption of surplus liquidity from the system, but without the need of providing collateral in exchange, a (low) remunerated standing deposit facility may be introduced, with the discretion to set the interest rate.

Consistent with the Fiscal Responsibility and Budget Management (Amendment) Rules, 2013, the Central Government needs to ensure that its fiscal deficit as a ratio to GDP is brought down to 3.0 per cent by 2016-17.

We believe that the report's recommendation wants risks to be hedged and managed which would bring India in line with global norms by placing less importance on wholesale price inflation.  Indian central bank follows a fixed approach to monetary policy and mainly setting interest rates based on how it sees inflation, currency stability and economic growth. RBI usually did not have an official inflation target, which often leaves markets hard to judge its moves. Nevertheless, lower inflation numbers (both WPI and CPI) and sluggish industrial productivity indicate that the RBI is likely to keep policy rates on hold at least in the near term.