The RBI appears to be satisfied with the contours of the Monetary Policy Committee as they stand today. However, given that there is talk of what the MPC should be targeting in future, the doors are open for discussion. Here we can pose some questions.

First, are we targeting only inflation? This is important because different Governors have expressed diverse views on the subject. While the legislative mandate speaks of only inflation targeting, it has been expanded to cover growth too especially last year. Therefore, it makes sense to also include a growth objective as perspectives of the same are expressed in the deliberations and the final MPC statement.

Second, which index do we look at? Here, there has always been debate on whether the CPI is better compared to the WPI. Let us look at the logic of inflation targeting. If inflation is very high, then it is necessary for rates to be increased so that excess demand-pull forces are reduced, and inflation tempered.

Here, the assumption is that inflation is being caused by demand going ahead of supply. Also, it is implicit that this growth in demand is being driven by business borrowing money and investing. By raising interest rates this is curbed.

Let us look at the reverse situation. If inflation is low, there is reason to lower rates so that businesses borrow and invest more. This leads to higher growth. Intuitively lowering of rates is growth accretive while raising rates is inflation curbing. In both the situations the premise is that interest rates affect borrowing decisions. The CPI is a consumer-based index and has 46 per cent weight given to food items, 10.1 per cent to housing, 6.8 per cent to fuel and lighting, 8.6 per cent to transport and communication, 5.9 per cent to health, 4.5 per cent to education, etc.

None of these components is based on leverage and hence repo rate action will not affect this index. Individuals do not use leverage to finance these purchases (except through credit cards which are anyway just 1 per cent of total credit).

Therefore, the assumption is that rates will affect business decisions and not inflation. But, then, if this is so, we should be looking at the WPI as that is a production index which assigns a weight of 64 per cent to manufactured products.

But don’t the two indices move the same way? The answer is: not always. The CPI is driven more by food products, as was seen in FY21, and guided more by supply shocks over which interest rates have no impact.

Thus, the third question. Should we be looking only at headline inflation or also core inflation? This is important as the MPC statement is always eloquent on the latter as it often emphasises how core inflation is low even though headline is high because of high food prices. As there is a bias towards growth and hence low borrowing costs, the decision to not increase rates even when inflation is high assumes that it is the food component that has gone awry and hence is not a monetary concern.

Fourth, another issue that comes up in discussions post the announcement of the policy is the concept of real inflation. Often it is explained that real interest rates are very high because inflation is low and the repo rate is high. Is this important? Here it should be pointed out that inflation is always cumulative and hence over five years of, say, 4 per cent inflation, the cost of living has actually gone up by 22 per cent, while the interest rate refers to a point of time. Therefore, a call has to be taken on whether real interest rates make any sense or should it be ignored.

This is important because it leads to the fifth question of whether one should be looking at the returns for savers. They get affected by cumulative inflation and can never understand how their deposits are earning just 5 per cent when food inflation is very high and the repo rate very low.

The question is: Why is it when inflation rises, interest rates are never increased? Savings are important because if they do not increase, ex post will lead to a current account deficit which is what macroeconomics says is the difference between savings and investment.

The sixth question is that when we specify a band, what is one to make of it? A band of 2 per cent over a benchmark of 4 per cent today is treated differently by the MPC. When the inflation path moves downwards along the range, rates have been lowered, but when they go up towards 6 per cent, they have not been touched.

The MPC must consider at what stage does the committee change rates in either direction. While 2 per cent and 6 per cent are well defined, the action taken between these limits is still open to interpretation.

The seventh question is what does an “accommodative stance” mean? Does it mean that rates will not be increased or that liquidity will be provided when required? This is another open question as it has been an addendum of all the last few policies.

The eighth is, what should be the inflation target given that we opt for CPI? Interestingly, before the MPC started its first meeting in October 2016, the average inflation rate in the preceding four years was 7.5 per cent and, yet, 4 per cent was chosen. For all the eight years (excluding FY21) the average has been 5.8 per cent. Even the CPI for industrial workers had averaged 8 per cent in the earlier four years and 6.5 per cent for eight years ending FY20. Therefore, a number of 5 per cent looks more reasonable in the Indian context. To this one can add 2 per cent band on either side which is a deviation of 40 per cent.

The ninth question is whether there should be six meetings or should we revert to the earlier system of two policies — the so-called busy and slack seasons. This is so because every policy makes projections of the future which become susceptible to substantial changes.

Last, the three-day meeting concept can be reconsidered as the perimeter for discussion is fixed and there are limits for debating numbers which are on the table. This can reduce the market noise as players start conjecturing action possibilities from Day 1.

The writer is Chief Economist,

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