Reserve Bank of India Governor Raghuram Rajan's response in an interview with a television channel in Sydney last Monday once again raised the old question: can the RBI and the finance ministry find common ground on critical macroeconomic issues? Or is the very nature of the arrangement inherently against this? Dr Rajan was responding to a question about differences of opinion on the RBI's proposal to adopt a monetary policy framework that targets inflation measured by the consumer price index . Two specific statements made by ministry representatives gave the impression that it was opposed to this proposal. When the report containing the proposal was released, the economic affairs secretary said that this approach was not appropriate for a country in India's situation. More recently, and pointedly, the finance minister in his interim Budget speech said that the RBI should be careful in balancing its inflation management objectives with keeping growth on track. The governor's assertion that the RBI and the ministry were on the same page on the issue of inflation targeting could be seen as an effort to present a united face on the issue, in the process quelling fears of a recurrence of conflict between the two.
There is an irony in the way that this difference has emerged. Dr Rajan pointed out that the ministry could not be conceptually against inflation targeting, since committees appointed by it had recommended this. The committee chaired by Percy Mistry, and then later by Dr Rajan himself (though this was formally set up by the Planning Commission), advocated this approach. The Financial Sector Legislative Reforms Commission (FSLRC) also proposed a monetary policy architecture similar to the one laid out by the committee headed by Urjit Patel. The Indian Financial Code, which the FSLRC designed, has been strongly endorsed by the finance ministry. So, why the volte-face by the ministry on such a significant issue? Presumably, the pressure that the government is facing from the business community to do anything and everything it can to arrest the slowdown is overriding its willingness to endorse a policy framework that it has apparently supported in the past.
What needs to be appreciated about the Urjit Patel committee recommendations, though, is just how contingent the framework is on actions taken by the government. Dealing with food inflation and other supply constraints is a necessary condition for the framework to be effective. Containing the fiscal deficit, reforming the administered price mechanism for several key commodities and facilitating the development of the government securities market by phasing out the statutory liquidity ratio are indicated as important reforms required to make inflation targeting work. Time was when the ministry criticised the RBI for standing in the way of reform. Now, even after the RBI has itself accepted the merits of a different approach to monetary policy, the criticism still persists. It must realise that, in the absence of politically difficult reform, nothing that the RBI does or does not do will bring inflation under control.
