The government and the RBI appear firm in their intent to keep nominal interest rates low but there is a necessary corollary to this viz low inflation rates. The low inflation rate has given power to the arm of the monetary-fiscal expansionists. Even without pump priming the inflation rate will start rising in the next financial year, purely as a statistical phenomenon, which will trigger market expectations.
In his budget speech for 2000-01 the finance minister had said: In a fast changing world of modern finance it has become necessary to accord greater operational flexibility to the RBI for conduct of monetary policy and regulation of the financial system. Accordingly, I intend to bring to Parliament proposals for amending the relevant legislation. The Parliamentary legislative process being what it is, neither the RBI nor the banking legislation amendments put before Parliament by him have seen the light of day. To continue with the tilt towards low nominal interest rates, it is essential to take visible action in terms of some sort of commitment on inflation control. While governor Jalan has indicated his hesitation about a single inflation target, credibility for interest rate objectives would require some action on what range of inflation the authorities are willing to tolerate.
The Committee on Capital Account Convertibility (May 1997) had recommended that consistent with an increasing level of integration of the Indian economy with the world economy, the mandated inflation rate could be an average of 3 per cent to 5 per cent over a three year period. The Advisory Group on Transparency in Monetary and Financial Policies (September 2000) had advocated that the monetary policy objectives need to be set out in simple language intelligible to the general public and recommended that a single medium-term inflation objective say, over a prospective three year period, could be set out by the government which, while doing so, could take into account all its other policy objectives. There would, of course, need to be a right to reset the single objective but such resetting should be infrequent and the rationale should be transparent and made public.
A clear and coherent inflation mandate, as internationally understood, is obviously not on the cards as the RBI has, for good reasons, not wanted to be trapped into a mandate for which it does not have the institutional safeguards to operate its policies. But a start could be made with the finance minister setting out a statement of intent of policy on inflation. Initially, it should suffice if there were a clearly set out guideline in the budget speech that the endeavour would be to keep the average inflation rate over the next three financial years within a range of 2 per cent to 4 per cent, and that the RBI would initiate work, in consultation with government, to operationalise such a framework. There is no point quibbling that we do not have a reliable price index. We use all sorts of indicators for policy purposes and the WPI could just as well serve the purpose.
Operationalising a medium-term inflation objective is not easy and an approach of shoot the governor if the mandate is exceeded would be ridiculous given the present state of monetary-fiscal policy mix and institutional constraints. Nonetheless, it should be possible to initiate work between the RBI and the finance ministry with indicative triggers where policy action is taken when the inflation rate continues to be outside the upper bound over the indicative target for a specified period, say three months. It would be possible, over a period of time, to have an unequivocal inflation mandate with specific responsibilities for the RBI to attain the inflation target.
Sanjaya Baru in his column in this paper on January 25, 2002 had made the point that given that global inflation has trended downward the acceptable threshold inflation rate has to be lower then our earlier tolerance levels of a 5 per cent to 6 per cent inflation rate over the medium term. As the editorial in The Financial Express of January 29, 2002 stressed, the present low inflation rate in India is also a manifestation of globalisation and we cannot be out of step with the present global reality defined by subdued inflation.
RBI and finance ministry officials would have read the speech of Donald T Brash Inflation targeting 14 years on (Bank of International Settlements Review No 5 January 21, 2002). Brash observes that when inflation targeting was first introduced in New Zealand in 1988, inflation rates had moved into single digits for the first time in 15 years. The finance ministers concern was that the public would expect monetary authorities to ease up and settle for inflation in the 5 per cent to 7 per cent range. He indicated in some loud thinking that his interpretation of genuine price stability was around 0 or 0 to 1 per cent which then broke inflationary expectations!
While Brash provides illustrations of the advantages of inflation targeting, he also discusses the travails of the central bank when fiscal policy is hostage to political factors. He does, however, make the telling point that the core elements of inflation targeting are not more complex than operating other approaches to monetary policy. That high inflation hurts the poor the most must be borne in mind by the advocates of a little more inflation. There can be no better pro-poor policy than an inflation mandate. But we do not seem to have the stomach for it.