Ministry of Finance to Implement New Monetary Policy by New Year

October 11, 2014 Posted by India Briefing Reading Time: 4 minutes

RBI Central Board Meeting DELHI – India’s Ministry of Finance has announced a new monetary policy framework to be put in place by the New Year. Details have not yet been finalized but will be confirmed by the end of December in order to be included in Parliament’s Action Taken Report, due in January.

The framework signals another attempt by India’s Finance Minister Arun Jaitley to reign in the Reserve Bank of India’s (RBI) control over monetary policy. Jaitley has made a point of setting aside the historically acrimonious relationship between his predecessors and the central bank, meeting with RBI Governor Raghuram Rajan to settle on an agreed path of inflation: eight percent by January 2015 and, more ambitiously, six percent by January 2016, with a medium-term inflation target of four percent with a 2 percent band either way.

The redistribution of responsibility will also award the RBI greater independence by clarifying its latitude in policy-making. The Ministry of Finance official who announced the monetary framework emphasized that, “The appropriate inflation target for India cannot be decided by the RBI. It has to be decided by the government.”

The new framework will see the government setting inflation targets with a new monetary policy panel deciding on interest rates. Headed by Raghuram Rajan, the panel will consist of two other members of the central bank and two external members and replaces the current practice whereby the RBI Governor is solely accountable.

Rather than making amendments to the RBI Act, the new framework is expected to be determined through agreements between the Finance Ministry and the central bank. “The amendments will ideally be done when the more comprehensive amendments suggested by the Financial Sector Legislative Reforms Commission are taken up,” the official commented.

Overall, this restructuring marks the first steps to having “a more modern monetary policy framework to meet the challenge of an increasingly complex economy,” which Arun Jaitley set forward in his July budget. Published this week, however, the mixed message of the IMF’s Global Financial Stability Report has reminded us of the scale of that challenge.

Unlike in other emerging markets, inflation in India has eased; a trend which will be encouraged by increased government control over policy. Noticeably, however, debt-service capacity has declined, leaving the economy vulnerable. In addition, India’s loss absorbing buffer in the corporate and banking sector remains the lowest in Asia, with its provision coverage for Non Preforming Loans the second lowest.

So, whilst the new monetary framework certainly is a positive move in working towards a banking system increasingly in line with global practices, those hoping for a more complex solution to India’s financial instability will likely remain unsatisfied.

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