Lets Aim at a Moving Target

Context: Changes should be made to the current flexible inflation targeting framework to make it more consistent with the economic realities on the ground.

Issues with the monetary policy framework:

• Excessive importance given to CPI: at the cost of ignoring other indicators like WPI (represents essentially the manufacturing sector, which remained negative during a large part of 2020).
  • This has an impact on the calculation of GDP deflator, as it uses both CPI and WPI with the latter having a greater weight.
• Narrow mandate of given to the non-RBI members: Currently, the three non-RBI MPC members are allowed to provide views only on the repo rate.
  • It may not serve its purpose effectively because the market-clearing money market rate is at or below the reverse repo rate.

Key Factors for Reviewing Existing Monetary Policy Framework:

• Consider both headline Consumer Price Index (CPI) and blended core inflation parameters: to make current accommodative stance consistent under the flexible inflation targeting framework.
  • While the Headline CPI inflation (led mainly by higher food prices) has been over 6%, an average of core CPI and core WPI inflation in the same period is just 2.8%;
  • Core average WPI inflation (non-food manufactured goods inflation) has only been 0.4%;
  • If the Monetary Policy Committee (MPC) is focusing solely on CPI inflation, then the GDP deflator should also be calculated using only CPI inflation, reflecting lower GDP growth.
• Expand the mandate on non-RBI member: by allowing them to take a call on reverse repo, Cash Reserve Ratio (CRR) rate, extent of liquidity surplus or deficit, and Open Market Operations (OMOs)
• Develop a Dot-Plot Matrix: Each MPC member should provide a ‘dot-plot’ showing up to what time they expect the accommodative stance to continue, based on their individual assessment of the growth-inflation dynamic.