Radical change in policy approach

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SummaryAt the heart of it is the efficient financing of India’s growth potential

A day before RBI Governor Raghuram Rajan’s first major review of monetary policy (MP), it is useful to consider the medium term implications of broader financial sector reforms. Rate actions (repo, MSF, CRR, SLR, refinance, etc) get the most attention during a MP review, owing to the immediate consequences on bond yields, banks’ lending rates, the rupee, banks’ profits, etc. Most analysts are focused on this. But the actions also need to be evaluated over the years and across sectors, with a view to setting a context of future actions.

Statements and comments from Rajan and his team suggest a major change in approach to financial sector reforms. Some of these steps will be incremental, advancing measures already taken, others will be more radical and unconventional. Some of this will get reflected in the forthcoming report of the committee on monetary policy reform; some, in the final version of the paper on structure of the banking sector; and some more, in the ongoing implementation of the Financial Sector Legislative Reforms Commission (FSLRC). Coincidentally or otherwise, the various strands appear to be converging towards the recommendations of the report of Committee on Financial Sector Reforms (CFSR), ‘Hundred Small Steps’, then chaired by the current Governor. What are the practical consequences of this line of thought?

The following are ten major facets of change in India’s financial sector we think are likely to happen over the next couple of years (with some help from Rajan’s statements).

1. The most immediate signal will be inflation. Inflation will become the primary target of monetary policy, with other components of Multiple Indicators becoming more diffused. Right up front in Rajan’s very first statement on the day he assumed office: “The primary role of the central bank, as the [RBI] Act suggests, is monetary stability, that is, to sustain confidence in the value of the country’s money. Ultimately, this means low and stable expectations of inflation, whether that inflation stems from domestic sources or from changes in the value of the currency, from supply constraints or demand pressures”. In other words, inflation is inflation!

* A shift to greater rule-based versus (at least a perception of) the discretionary approach to monetary policy. This will enhance Governor Subbarao’s lasting legacy of having introduced greater transparency and communication. “[RBI] should be a beacon of stability as to its objectives … (and) the public should have a clear framework as

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