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The widely-awaited Patel committee report to revise and strengthen RBIís monetary policy framework, the first of RBI Governor Raghuram Rajanís five pillars of focus, was released recently. It recommends wide-ranging changes, significant amongst which are: a shift to flexible inflation targeting (FIT), making price stability the predominant objective ahead of growth and financial stability; adoption of headline CPI as nominal anchor (medium-term inflation target - 4% in a 2% band); wider decision-making structure with a formally constituted committee and voting; phased changes in the operational framework, including transfer of debt management to the government; and institutional reform on the fiscal side to eliminate financial repression, viz SLR, administered interest rates, and so on.
Most market analysts, excepting a few, have welcomed the key recommendations with the presumption that Governor Rajan will readily accept those within the purview of the central bank without much debate or delay. Expectations are he could possibly give some lead in tomorrowís monetary policy review itself. At the top of their expectation agenda is a formal announcement to shift to flexible inflation targeting (FIT) with headline CPI as the nominal anchor. In anticipation, bond yields firmed up last week, reversing an easing trend observed since the sharp correction in December headline inflation.
Without going much into the merits or demerits of these recommendations, we would like to focus on how far the market is right in its belief that Governor Rajan will readily accept and implement these without more debate or discussion. If, indeed, these policy actions were in the pipeline, as the market has anticipated ever since he took charge at Mint Street, then what led Governor Rajan to express his views on these very issues, some of which were in complete contrast to the committeeís recommendations, in a few press interviews just a month before the reportís formal release? Given that these views were more practical and accommodative of Indian realities compared to that of the Patel report, it merits highlighting the divergence: Flexible inflation targeting recommended by the committee makes price stability the primary objective with a 2 percentage point band to accommodate temporary shocks, other concerns etc. The theoretical underpinning of its analysis is the new Keynesian framework of monetary policy that works via the inflation expectations channel.
The Governor, on the other hand, displayed a rather practical mindset keeping in mind that India is a developing economy. Hereís what he says: ďÖin a situation