#dnaEdit: A tricky deal

The monetary policy agreement signed between the Reserve Bank of India (RBI) and the ministry of finance on February 20 this year is, on the face of it, a transparent and sophisticated instrument which will ensure macro-economic stability as well as transparency. RBI governor Raghuram Rajan and secretary in the ministry of finance Rajiv Mehrishi are the signatories to the agreement. The terms set are interesting. It mandates that the inflation rate should be brought below six per cent by January 2016, and that it should be four per cent for 2016-17 and subsequent years. The RBI will have to “report to the Government” if it fails to meet the target. 

The best weapon that the RBI has at its command to put inflation on the leash is through calibrated interest rates. The question is to whether it will do so on its own or it will be a mere instrument of the government of the day in managing the economy. One of the problems during the relatively closed-economy decades until 1991 was that the government could direct the RBI to allow for a liberal money flow, that is printing of money, to meet expenditure. Runaway inflation was often the outcome. It seemed necessary that for a stable monetary climate, governments should be kept out of the decision-making to print money and to set interest rates. It is the macro needs of the economy that should determine the levels of currency supply and the interest rates  needed to maintain macro-economic stability. 

In the last few years, finance ministers have been rather impatient with the RBI for not reducing the interest rates to boost economic growth even during times of recession. It seems that the February monetary policy agreement between the government and RBI is a way to facilitate the government’s economic  agenda to prevail over that of the RBI. Whatever its fallibility, the central bank would be guided by economic factors. The temptation for the government is to garnish economic figures for political advantage. The agreement, of course, makes it obligatory for the RBI to publish its procedures to meet the inflation targets, or its failure to do so. It is necessary then for the public to keep a watch over the tweaking of inflation targets. 

The examples of the US Federal Reserve and the Bank of England are sure to be cited to defend the monetary policy agreement. In its “Statement of Longer-run Goals and Monetary Policy Strategy”, the Fed acknowledges the statutory mandate from the Congress “of promoting maximum employment, stable prices and moderate long-term interest rates”. But the long-term rate of two per cent has been set by the Fed and not by the Congress. It is different in Britain. The Bank of England in its “Monetary Policy Framework” explicitly states that “monetary policy objective is to deliver price stability — low inflation — and, subject to that, to support the Government’s economic objectives including those for growth and employment.” It also acknowledges that price stability is defined by “the Government’s inflation target of 2%.” 

It seems to be the case that governments do not any more trust free market forces. In normal circumstances, it is the market which should determine the optimal price and inflation rates. Governments are keen to control extreme market volatility. There is reason to suspect that in the Indian case, the ministry of finance, setting the inflation targets, is only looking to push for growth rates, and there is no broader social commitment towards employment or price stability.