Annex B

Consultation Meeting of the Committee with Economists/Analysts
(Held on December 18, 2013)

The Committee engaged in informal consultations with nine experts/economists/analysts (listed below) at a meeting held on December 18, 2013.

1) Professor Vikas Chitre
2) Professor Dilip Nachane
3) Professor Ashima Goyal
4) Dr. Renu Kohli
5) Dr. Soumya Kanti Ghosh
6) Dr. Ajit Ranade
7) Dr. Tushar Poddar
8) Mr. Chetan Ahya
9) Mr. Niranjan Rajadhyaksha

The summary of discussions is organised around the key issues.

(1) Nominal Anchor for Monetary Policy

Two broad sets of views emerged on this issue: (a) abandon the current multiple indicator approach as it has no clear nominal anchor, and switch over to explicit inflation targeting (IT), with inflation as the nominal anchor; and (b) continue with the current multiple indicator approach, despite lack of any explicit nominal anchor, as this framework draws on the high credibility earned by the RBI over years and allows flexibility to the RBI to respond to multiple macro-financial challenges.

Those who supported the first viewpoint argued that the current multiple indicator approach has failed to deliver price stability, primarily because of the pursuit of multiple objectives and the scope for time - inconsistent behaviour in the short-run. India is also the only major EME (excluding China) which has not yet adopted explicit inflation targeting. Cross country experience of EMEs suggests that after switching over to IT, the performance on inflation has generally improved. In this view, “flexible inflation forecasting targeting” was seen as appropriate with uncertainty surrounding inflation projections accommodated by operating with an ex ante target, but allowing for discretionary response to shocks. In the case of demand shocks, the monetary policy response is obvious, but in the case of supply shocks, discretion will be critical because of the asymmetric impact on inflation and growth. Accommodation of supply shocks is a matter of judgment and cannot be left to a simple rule.

Those who favoured the second viewpoint underscored the point that the theoretical and empirical basis for IT is weak, and a switch over to IT in India driven entirely by the inflation experience of the last few years must be preceded by clarification on how IT will be made consistent with exchange rate stability and financial stability. Some also suggested that there must be clarity on how a new framework would respond to asset prices, unlike the ambiguity in the current framework. There was a view that a nominal anchor alone may not guarantee price stability, since the RBI had adopted monetary targeting in the past, but that regime was not any way better in terms of performance on price stability. A nominal anchor, therefore, could work only if fiscal policy works in tandem with monetary policy.

(2) Choice of the Inflation Metric

Views were divided on this issue, with some favouring headline CPI, and others supporting a core measure of CPI that is sensitive to changes in monetary policy. The key arguments against a core measure of CPI were: (a) the importance of food and fuel in the consumption basket in India; (b) food and fuel also reflect the impact of demand pressures and not just the impact of supply constraints; and (c) transmission of food and fuel inflation to inflation expectations and wage setting behaviour. The arguments against the use of headline CPI inflation included: (a) the all-India CPI is a new index and its properties – particularly its relationship with other variables – are not very clear; (b) there are macro risks of shifting to the new CPI at a time when growth is weak and the political environment is uncertain – the key risk is of raising interest rate significantly, conditioned by the high CPI inflation but, possibly, not being able to lower inflation despite a strong anti-inflationary stance; (c) public preference in a democracy matters and people may accept higher inflation if that helps in higher growth.

All supported the need for a robust inflation expectations survey, and measures to deepen the market for inflation indexed bonds so as to obtain market based information on inflation expectations. It was felt that this will help improve understanding of relationships between CPI or its specific components and inflation expectations.

(3) The Inflation Target

There was a view that the RBI already has an implicit inflation target – often communicated in terms of 5 per cent as its comfort level. What may be required under a new framework, therefore, is clarity on single versus multiple objectives and accountability on attaining the target. Others felt that setting the target level is not an easy choice. Some suggested careful calibration of the time path over which the target may be pursued, being mindful of disinflation costs. Others were of the view that comparing the Mexican and Brazilian experience would suggest that Mexico has a lower inflation target (which does not allow much scope to accommodate supply shocks), therefore, its performance on price stability is better. In contrast, Brazil has a higher inflation target, which leaves scope for accommodating supply shocks, leading to relatively higher average inflation.

(4) Who should set the Inflation Target?

The view was that the target must be set by the RBI and not the Government – contrary to what is recommended by the FSLRC. The prime argument is incentive incompatibility, i.e., the Government may set a low inflation target, but ensure neither independence for the RBI nor fiscal prudence, thereby making the target unattainable for the RBI.

(5) Impediments to Transmission of Monetary Policy

One view highlighted uncertainty surrounding monetary policy transmission in India as a key factor that could constrain performance evaluation and hence fixing accountability under IT. If the action to outcome relationship is uncertain, persisting with the multiple indicator approach may be acceptable. A counter view was that the switch over to IT cannot wait for a well defined and understood transmission process to evolve. In this context, the example of Brazil was presented to suggest that countries have migrated to an IT regime without being constrained by transmission weaknesses and lack of clarity on how to anchor inflation expectations. On improving transmission, one view underscored the need to develop the term money market, another view suggested adding borrowings from the RBI to the calculation of the base rate. There was also a view that the large and growing size of the parallel economy may be a major impediment to transmission.

(6) Liquidity Management

It was highlighted that in a period of falling productivity, more provision of liquidity may not be a solution to the growth slowdown. The RBI should track productivity trends and must recognise that liquidity injected at negative real interest rates must be used productively; otherwise it will be inflationary. One view emphasised that liquidity conditions are more important than even the repo rate, and a policy of keeping the system in permanent liquidity deficit mode need not be ideal for all phases of the business cycle. Another view underscored the obvious connection between liquidity and asset prices and suggested that the new framework must recognise this.

(7) Other Issues

During the discussions several other specific points were highlighted, such as: (a) flexibility in the framework to respond to spillovers from the monetary policy stance of the reserve currency country (i.e., the US); and (b) use of credit policy as an adjunct to monetary policy aimed at addressing supply constraints; and (c) use of macro-prudential policies for financial stability objectives.