Soon after the Monetary Policy Committee (MPC) ended its legal tenure at the Reserve Bank of India (RBI) on 6 August with a clinical decision to hold interest rates, all focus shifted to the selection process for a new lot of members. Coincidentally, the new MPC, its members and its immediate remit—which includes finalizing a flexible inflation target for the next five years—are all in a flux at a time when central banking globally is also at a crossroads. And though the challenges are very different, it will be interesting to see how these global trends influence Indian central banking and its inflation targeting regime.
- Three external members will be selected to join three existing RBI nominees. The process involves intense negotiations between the central bank and government on identifying candidates with fealty to monetary policy. For example, the last MPC’s voting patterns clearly revealed the government nominee’s identity and policy stance.
- The MPC framework is governed by the RBI Act, which also lays down the composition of the search committee: cabinet secretary, RBI governor, economic affairs secretary and three external experts handpicked by the government. Clearly, the skew favours New Delhi.
- This comes when the pandemic has shown the limits of central bank action in the absence of fiscal intervention.
- The government and market expect RBI to single-handedly jump-start the economy, which has been almost comatose since demonetization in late 2016.
- RBI has slashed rates severely, poured inordinate liquidity into the system and indulged in extraordinary regulatory forbearance.
- The first is at odds with global trends. Most economies entered the covid phase with stronger banks, because of work done after the 2008 financial crisis, but weaker and over-leveraged corporate sectors. In India, both are vulnerable, with banks more so.
- It is true that many corporates are over-stretched and face bankruptcy; but it is equally true that the corporate sector’s loan binge has left banks, especially state-owned, deeply scarred and starved of capital.
- The second issue, thus, is whether inflation targeting offers a limited playbook for tackling the current crisis. The past few months saw RBI governor Shaktikanta Das occasionally crossing the monetary policy perimeter, making unilateral changes to the reverse repo rate without reference to MPC members.
- Finally, the efficacy of changes in the monetary policy framework and its impact on fostering price stability or growth depend on the central bank’s communication policy.
- It should be remembered that its segue from two “credit" policies a year to six monetary policy announcements was necessitated by the increasing centrality of markets to monetary management or price stability, and the need to convey the central bank’s thought process to agents clearly.
- Its communication policy springs from the International Monetary Fund’s transparency code of 1999. That code has now been updated under the guidance of a high-level advisory group, which included former RBI governor Y.V. Reddy.
- The new code is voluntary and comprises five pillars of transparency: governance, policies, operations, outcome and official relations (say, with government or international counterparts).
- Although RBI is under no compulsion to accept it, increased transparency will be critical for central bank credibility in asset markets and improving transmission from benchmark rates to real lending rates.
- The burden of expectations on the new MPC will be heavy: recognizing threats to future financial stability, reorganizing the tools at hand, and clearly communicating actions to markets.