4 min read.Updated: 01 Nov 2022, 11:31 PM ISTAjit Ranade
RBI’s letter of failure to the Centre should be made public and our policy framework put to fresh debate
In 2016, the Government of India signed a contract with the Reserve Bank of India (RBI), making the latter responsible for a numerical inflation target within a band. This was our transition to a flexible inflation targeting regime, hailed as a major reform, and a step toward strengthening central bank independence. It wasn’t as if RBI’s mandate was not clearly understood prior to this reform, but the numerical target and explicit responsibility was new. In the event it failed to fulfil its mandate, there was a consequence spelt out. This was that RBI would have to “explain" to the government its failure at inflation control. Indeed, RBI has failed for the past two years, as inflation stubbornly stayed above 6%, the upper end of the band. There are no grace marks in this exam. Even 1% outside the band is counted as failure. There are some murmurs that an exclusive inflation mandate was a bad idea and central bank independence is an idea that’s being repudiated worldwide. Yet an explanation letter from the offending party is to be dispatched shortly from Mint Street to Delhi. Alas, neither Parliament nor the public will be privy to its contents. Why the secrecy? In an era when even the minutes of Monetary Policy Committee meetings and identities of individuals and how they voted are made public, what is so sensitive about an explanatory letter? It is not that an uncomprehending public is being spared esoteric language and mathematical models, which are the presumed content of this letter. Is it because RBI might reveal the true burden of a fiscal overhang that makes its job so difficult? Or that its ‘independence’ has been drastically compromised? RBI has in recent years found that despite using the powerful ammunition of sophisticated models and extensive survey data, besides various monetary tools at its disposal, not only is inflation difficult to tame, it is also difficult to predict. RBI has underestimated inflation many times. There are several reasons for this, global and local. India’s inflation is dominated by food and fuel, and RBI is not alone in finding itself unequal to this task. Look at central banks around the world as they struggle with post-war record inflation, and now face the blame for acting too late as inflation expectations get entrenched. Look at extreme price volatility (remember that the West Texas benchmark oil price was briefly a negative $37.6 per barrel in April 2020!). So, inflation prediction and management is an intractable problem by its very nature. That does not mean we should not entrust central banks with the task of protecting the value of our currency.