Governor Raghuram Rajan’s policy of tight leash on inflation has showed results and the Reserve Bank should continue with similar policies and communication going forward, Moody’s Investors Service has said.
Moody’s Investors Service Senior VP Sovereign Risk Group Marie Diron said credibility and effectiveness of monetary policy are factors which impact India’s sovereign ratings. Moody’s has a ‘Baa3’ rating on India, with a positive outlook.
“In the last two years, India’s inflation has fallen to more moderate levels, likely in part because of more credible monetary policy that has anchored inflation expectations. We expect the RBI to continue with similar policies and communication, showing commitment to achieve its inflation target,” Diron said.
A monetary policy with tight leash on inflation is important especially in India, where in the past inflation has risen to very high levels, negatively affecting growth and investment prospects.
Rajan, who demits office on September 4, has been pilloried by his critics for keeping interest rates high and has also been accused of stifling growth.
Rajan had challenged these critics to show how inflation is “very low” before accusing him of “being behind the curve” in his focus on containing price rise than on growth.
Consumer price index or retail inflation rose by 6.01 per cent in June, the fastest pace in 23 months and it is expected that the implementation of the new Goods and Services Tax (GST) may push up inflation further.
Diron also said that inflation targeted monetary policy enhances transparency and is suited for India’s specific economic and institutional structures.
“In India, inflation targeting has likely contributed to enhancing the transparency and predictability of monetary policy, two important elements to foster its credibility and effectiveness,” she said.
Diron said with around half the consumption basket consisting of food, whose prices are less predictable than others, India’s inflation will continue to face periodic upside risks.
“If credible, monetary policy can contribute to preventing food-driven spikes in inflation from spilling over to other prices and wages,” she said.
The government, in consultation with the RBI, has set an inflation target of 4 per cent within a band of (+/-) 2 per cent for five years to 2021.
The next monetary policy on October 4 is likely to be decided by a six-member interest rate setting panel, instead of the present practice of RBI governor deciding the interest rate.
The Monetary Policy Committee (MPC) will set interest rates by majority, with a casting vote for the central bank governor in the event of a tie.
Out of six members of MPC, three will be from RBI — the Governor, who will be the ex-officio Chairperson, a deputy governor and an executive director.
The other three members will be appointed by the central government, on the recommendations of a search-cum-selection committee, which will be headed by the Cabinet Secretary.