Editorial 1: Lens of Inflation Targeting
Recent Context:
- Recently. RBI decided to Reserve Bank of India (RBI) decided to stop raising interest rates.
- This was quite odd because since May last year, the RBI had been exchanging jabs with high inflation, trying to bring it down close to RBI’s target level of 4% by repeatedly raising interest rates.
Role of RBI in controlling the inflation:
- RBI is one of those central banks that have responsibilities to limit the inflation withing the targeted limit. It primarily does this by raising interest rates in the economy.
- Higher interest rates drag down economic growth because loans of kinds become costlier. In essence, and this is the key point, the RBI hits overall demand to bridge the gap between what is demanded and what is supplied, thus bringing down prices.
- For instance in the US, the Federal Reserve has been hiking interest rates, thus dragging down overall demand and economic activity, in its bid to achieve its target of 2% inflation.
- However, in doing so, the Fed is running a very high risk of pushing the US economy into recession. While a recession is not what the Fed may want, it is supposed to not care beyond a point because it has to achieve the 2% inflation target.
- In RBI’s case, what is the Inflation target?
- Under the Under Section 45ZA of RBI act1934, RBI has to maintain inflation with upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent, therefore provides more flexibility to RBI that US federal reserve.
Why was RBI’s decision surprising?
- As in the last , the last two readings (January and February) inflation were 6.5% and 6.4%, respectively.
- To be sure, the RBI’s legal mandate gives it a leeway of +/- two percentage points either side of 4%. That means RBI has a comfort zone of 2% to 6% within which inflation must remain.
- Therefore , decided to assess the impact of previous raise in repo rate
The Monetary Policy Committee and its composition:
- The Monetary Policy Committee (MPC) constituted by the Central Government under Section 45ZB RBI Act, 1934 determines the policy interest rate required to achieve the inflation target.
It has 6 Members
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What could be the real reason for the RBI to pause?
- In the last meeting in February, RBI raised repo by 25 basis points by a majority of 4-2. One of the two dissenting members (both were government-nominated ones)
- While opposing the hike, some points were raised : Some of her key points were:
- It may be time for fiscal policy (the government) to help out in bringing down inflation.
- As “The large commodity component in India’s consumer price basket, and pockets of supply constraints, respond better to fiscal action,” .
- Along with there is need to cut in excise taxes, fuel prices. In other when inflation is pushed up by supply bottlenecks and costs instead of being pulled up by demand — monetary measures were not enough to contain inflation and needed fiscal (relating to government’s taxes and spending) action.
- Secondly, As inflation is driven by supply-side bottlenecks then rising repo rate will not be effective.
- Lastly, and most significantly, she warned against raising interest rates because they cannot only hurt growth but also be counter-productive from the perspective of containing inflation per se
What is the efficacy of inflation-targeting
- Contrary to the notion of an overheating economy, which experiences inflation because demand outstrips supply, in India’s case it is the supply costs and bottlenecks that have created inflation, not an economy running hot.
- Therefore, in India, inflation is often driven by supply-shocks originating and operating through the food economy. And merely raising interest rates doesn’t help beyond a point; indeed, it is counter-productive.
Conclusion:
- As inflation is driven by demand and supply factors, raising interest rates could lead to a reduction in money supply and inflation control but it will hamper economic growth.
- Given the fact that in India inflation is mostly due to supply factors. therefore, both demand and supply factors should also be considered by MPC.
Editorial 2: Regulating the regulators
Context:
- The establishment of statutory regulators constitutes one of the most significant governance reforms of the last century.
- There is a global surge in the popularity of such agencies as an alternate mode of governance. To deliver on this potential, regulators need to be well governed. Governance of these agencies centres around their governing boards (GB).
Five design features relating to GB can significantly improve the governance of regulators.
- First, the law typically creates a board governed by a board, an authority by an authority, a council by a council, a commission by a commission:
- For example, the Securities and Exchange Board of India Act, 1992 establishes a board, namely, the Securities and Exchange Board of India.
- The general superintendence, direction, and management of the affairs of this board vests in a board of members. In simple words, the former board is an entity, while the latter is its governing body (GB).
- Most statutes, however, do not distinguish between the two. As potential for mix-up or reversal of roles, making it difficult for the GB to steer the entity, establish its objectives, and hold it accountable for delivering on its objectives
- Second, Diversifying the governing body to maintain the accountability of management:
- it is normally difficult for an entity to take decisions about itself or its working with complete objectivity or hold itself accountable for its conduct or performance.
- That is why decisions about a company, for example, and process design are placed in the board of directors.
- GB’s primary responsibility is to act as a hands-on principal to hold the management accountable.
- It may, however, be hard for a GB to hold the management accountable if it has only managers as members. Therefore, The GB, , needs to have appropriate external representation.
- Most statutes do not provide for this representation and the required interface between the regulator and society in the regulator’s governance.
- For eg. The presence of a few eminent persons in the GB as part-time members (PTMs) is one of the more effective options. They attend its meetings, vote on issues, and take decisions on its behalf along with other members of the governing body.
- Third, minimizing the role of politics within the Governing body:
- the government typically has a few official nominees on the GBs of regulators.
- The views of such nominees, being the representatives of the minister who is accountable to the legislature, carry disproportionately more weight in the decision-making process.
- Further, the government is often a market participant as well as subject to pulls and pressures from various interest groups.
- It may not always be possible for the official nominee to take an objective position in all matters coming up before the GB
- Fourth, Ensuring the independency of regulator by ensuring the a fixed tenure:
- the independence of a regulator critically rests on the professional strength of the leaders, namely, WTMs (including the chairperson) to withstand the influence of articulate interest groups and the pressures of fear and favour from any quarter.
- A term of 3-5 years for these positions comes in the way of such strength. An individual, who has the demonstrated capability, would not join a regulator for a 3-5 years tenure.
- A term of three years is very short and by the time the members acquire the required knowledge, expertise, and efficiency, one term will be over.
- If the regulators are to maintain true independence, they must attract younger individuals, who have demonstrated their capability in the relevant field, for a reasonable period of service.
- Fifth, Separating the role and responsibilities for better regulation:
- a regulator in India typically performs three functions, namely, quasi-legislative, executive, and quasi-judicial.
- The statute should envisage a separate organisational unit responsible for each of the distinct types of functions and powers.
- These units should operate at an arm’s length from one another to act as mutual checks and balances to address public law concerns relating to separation of powers.
Conclusion:
- Governing Body should be enabled to delegate executive and administrative tasks to different functionaries in the organisation, who would discharge the duties and functions on behalf of the regulator in the manner prescribed.
- Such delegation would enhance the organisational capacity to ensure timely service delivery as well as promote greater accountability.