Talking Point. The fleeting affair between RBI and CPI

The BSE Sensex collapsed nearly 6 per cent on August 24, one of its biggest crashes in over five years. In this context, let us imagine the following situation.

A new law will mandate the Securities and Exchange Board of India (SEBI) as chief regulator of equity markets, to ensure markets don’t fall beyond a 5 per cent range. SEBI is given a “target decline” range to adhere to. The law envisages setting up an “Investor Flows Control” committee with seven members — two from SEBI, four from the government and the SEBI Chairman with a casting vote. This committee will decide periodically whether SEBI should “ease” investor flows or “tighten” flows into the stock markets.

Much hoopla There erupts a massive debate on the lop-sided composition of this committee and the veto powers of the SEBI Chairman. Not about whether it is prudent to even go down this route. If this sounds facetious and inane, as it should, a version of this inanity is what is being played out in the current hoopla over the Reserve Bank of India‘s mandate for inflation target, deemed independence from the government and the powers of its Governor.

We are all now familiar with this regular routine — a hysterical build-up to an RBI monetary policy meeting, the government clamouring for lower interest rates, the RBI Governor countering with inflation statistics and all of this ending with bickering all around.

The RBI needs to be accountable for consumer price inflation is the proposed wisdom in a new Bill. Presumably, the weapon in RBI’s armour to control inflation is its ability to set interest rates (monetary policy) and dictate the cost of money. The task of setting these interest rates periodically will be assigned to a Monetary Policy Committee. The composition of this committee in terms of membership from RBI vis-à-vis government is cause for much consternation.

Keep it simple Amidst the fixation over the RBI’s interest rate policy, we are now also told that interest rates actually don’t have a direct and immediate impact on inflation. A recent RBI working paper suggests that inflation in India is determined first by global food prices, next by domestic food policy, third by monsoons and lastly, perhaps also by interest rates. Other economists jump in and quibble over whether international food prices matter more to inflation than domestic food policy, but agree (in)directly that RBI’s interest rates are not the primary determinants of inflation.

The RBI Governor Raghuram Rajan too acknowledges this and propounds how the RBI’s rate policy has to also cater to the common man’s future inflation expectations.

The only consensus among all seems to be that the RBI’s monetary policy is not the primary or significant determinant of consumer price inflation in India. So, the alleged weapon that the RBI possesses to control inflation is apparently a bow and arrow in today’s world of nukes and guns.

Governor Rajan confounds us by suggesting that while we know that this weapon alone cannot kill the enemy, it can somehow help moderate our fear of such enemies in the future. Thus, it is just plain bizarre that the RBI should be held responsible by law for an outcome for which it has no tools to significantly impact.

If the RBI’s policy rate, at best, has a tenuous relationship and at worst no relationship with inflation control in India, all these elaborate discussions on Governor veto or composition of MPC is plain moot. If its rate policies are blunt and useless, why is the RBI mandated with a responsibility for an inflation target in the first place? Proponents of slapping the RBI with an inflation target mandate argue that in the absence of any other alternative, the RBI should be held accountable for an inflation target.

That a misplaced objective is worse than no objective does not seem to resonate with these advocates who seek refuge under a Chicago Nobel Laureate’s wisdom on inflation for America in the 70s. Why not keep it simple by going back to the origins of central banking — make the RBI responsible for overall credit conditions in the economy that it seems to be more in control of.

When the protagonists (RBI and CPI) themselves admit to a fleeting affair, why should they be condemned to marriage with the overall economy as potential collateral damage?

The writer is visiting fellow at IDFC Institute, advisory board member of TVS Capital and former CEO of an investment bank

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