MUMBAI: The government silenced conspiracy theorists who speculated it would stuff the Monetary Policy Committee with nominees who would do its bidding to make life easier for itself and the industry.
The three candidates – Chetan Ghate, a professor from the Indian Statistical Institute, Pami Dua of the Delhi School of Economics and Ravindra Dholakia of the Indian Institute of Management, Ahmedabad – carry with them a diverse set of beliefs which may elevate the quality of conversation at MPC meets.
Ghate, a member of the Urjit Patel Committee on the Monetary Policy Framework, which has become the cornerstone of monetary policy making now, is a known inflation crusader. His research includes how interference in food prices setting could lead to higher inflation.
“It is a combination of academics, practitioner, and one with corporate experience,” said Soumya Kanti Ghosh, chief economist at the State Bank of India. “There is no government representative. Now, it is up to them to play the role.”
When the government gave a legal backing to inflation targeting and replaced the practice of RBI Governor setting rates with a six-member MPC, where the central bank and the government will have equal representation, many feared the government may pack the panel with economists sympathetic to its views. But its choice of Ghate who is also the member of the Technical Advisory Committee of the RBI gives comfort on neutrality .
It is a popular argument among some liberal economists that inflation in India is driven more by food, so using higher interest rates to slow price rise would be ineffective. But Ghate argued against it.
“The Reserve Bank of India should respond to changes in the terms of trade over time in a systematic way as outlined in our model, especially since the importance of food inflation in monetary policy setting over the last several years has become increasingly important,” Ghate wrote in a paper Terms of Trade Shocks and Monetary Policy in India this year co-authored by Sargam Gupta and Debdulal Mallick.
The MPC debates have the potential to go beyond inflation in arriving at the monetary policy decision as expertise on the impact of foreign exchange inflows and developments in the international financial markets would also be available.
Pami Dua, director of the Delhi School of Economics has written numerous papers on various topics including how during good times of overseas fund flows the central bank has to keep a watch to prevent unintended consequences like overheating.
While market determined exchange rate may be the mantra for the central bank, there may be times when there have to be active interventions, says Dua.
“Large capital inflows create important challenges for policymakers because of their potential to generate overheating, loss of competitiveness, and increased vulnerability to crisis,” Dua wrote in a paper co-authored with Rajiv Ranjan.”Unsterilised forex market intervention can result in inflation, loss of competitiveness and attenuation of monetary control. The loss of monetary control could be steep if such flows are large. Therefore, it is essential that the monetary authorities take measures to offset the impact of such foreign exchange market intervention, partly or wholly , so as to retain the intent of monetary policy through such intervention.” Even though all the nominees are academics, there is a need to be a counter to arguments from the mostly conservative group of economists who populate the MPC which include Governor Patel himself and Michael Patra, an executive director at RBI. That role may well be played by Dholakia of the IIM, Ahmedabad who is also serving on the board of many companies.
Dholakia has been a critic of former governor Raghuram Rajan who drove the conservative monetary policy by arguing there is no direct trade-off between higher interest rates and investments which in turn affected the rate of economic growth.
“The RBI Governor’s assertion on no serious trade-off existing between inflation and growth in the country does not get any support from recent empirical evidence,” Dholakia wrote in a paper titled Cost and Benefit of Disinflation Policy in India published in 2014.”On the contrary , deliberate disinflation would impose sizeable immediate cost of loss of output on the system.” There were estimates that suggested that 1 percentage point of deliberate disinflation may entail about 1% loss of potential output over short to medium term, and a gain of about 0.5 percentage points in the growth after 4 to 5 years, he said. It would take at least two years to recover the loss, assuming normal times. But if the economy receives a shock in these 6 to 7 years, the recovery would take longer.
For those who believe that inflation could be controlled by raising output than the cost of funds there is company in Dholakia.
“WPI-based inflation in India is currently arising out of the supply-side problems and not demand-side problems,” Dholakia wrote. “If the output growth increases, demand remaining the same, the inflation would immediately fall and the fall would be sharper in the long-run. On the contrary , supply remaining the same if demand is made to fall, say by tight money policy , both the prices and output would fall in the short-run leading to avoidable further costs on the economy .”
Whether interest rates rise or fall, if the RBI decides to be transparent about the debates the MPC conducts, the minutes of the meeting may probably be more insightful than the policy document itself.
Credits ET Realty