Rajan Panel Proposes 4% CPI Target in India Policy Overhaul

An Indian central bank committee proposed adopting a 4 percent consumer-price-inflation target by 2016 as part of a sweeping monetary-policy overhaul, a shift that signals elevated interest rates if adopted.

An independent monetary policy committee should set benchmark interest rates, the panel appointed by Reserve Bank of India Governor Raghuram Rajan recommended yesterday in a 130-page report. It also proposed the Indian government reduce its budget deficit to 3 percent of gross domestic product by March 2017, from a forecast of 4.8 percent this March.

“This represents a fundamental transformation of how monetary policy will shape up in the coming years,” said Gaurav Kapur, an economist at Royal Bank of Scotland Group Plc in Mumbai. “The move towards rule-based policy from a discretion-based one will bring more clarity to how policy works.”

Focusing on consumer prices would bring the RBI’s approach closer to counterparts from Indonesia to Europe to the U.S., where the Federal Reserve’s goal is to keep inflation around 2 percent. Rajan will review the benchmark interest rate next week as he seeks to curb the fastest price pressures in Asia even while growth remains near a decade low.

RBI rate policy should aim to reduce CPI to 8 percent within one year and 6 percent by 2016, at which point the 4 percent target would be formally adopted, the committee led by RBI Deputy Governor Urjit Patel said. The target should be at the center of a plus-or-minus 2 percentage point band, and there should be a rolling two-year horizon for meeting it, the panel said.

‘Extended Pause’

“It is difficult to see the RBI in a rate-cutting cycle if it really has to move to 6 percent in the next 24 months,” Indranil Pan, an economist at Kotak Mahindra Bank Ltd. in Mumbai, said in a research report today. “If the RBI starts to adopt these timelines and targets, we should be placed for an extended pause (and probably a few hikes as and when required).”

Rajan, a former International Monetary Fund chief economist, appointed the panel to review India’s monetary policy framework after taking over as head of the RBI in September. Indian interest rates will remain elevated as long as inflation imperils economic growth, K.C. Chakrabarty, a central bank deputy governor, said in a Jan. 2 interview.

Consumer-price inflation rose 9.87 percent in December from a year earlier, the fastest pace in a basket of 17 Asia-Pacific economies tracked by Bloomberg. Wholesale inflation was 6.16 percent, the lowest in five months.

‘Front-Loaded’ Increase

The panel’s recommendations may signal a rate increase when Rajan next reviews policy on Jan. 28, Goldman Sachs Group Inc. said in a note. Because CPI remains above the 8 percent 12-month target, there is a case for a “front-loaded” rate rise of 25 basis points, it said.

Rajan surprised economists last month by holding the benchmark repurchase rate at 7.75 percent instead of adding to increases totaling 50 basis points since taking over the RBI. He will leave the rate unchanged at the Jan. 28 meeting, according to all 18 economists in a Bloomberg News survey.

The rupee was little changed at 61.78 per dollar at 3:04 p.m. in Mumbai today. The S&P BSE Sensex gained 0.4 percent, while the yield on the 10-year bond rose to 8.61 percent from 8.55 percent yesterday. The Patel Committee report was released yesterday after the close of trading.


The RBI currently uses wholesale-price inflation as the main cost-of-living measure to guide policy. The index, which conflates retail and producer prices and fails to reflect services, is more than six decades old. The consumer gauge was created in 2011.

India has more than six inflation gauges, including a central bank in-house core inflation index that excludes food and fuel costs, and Rajan says he analyzes them all to set policy.

The Patel report cited “hardened inflation expectations, supply constraints and weak output performance” for the timeframe to phase in the CPI target.

“This transition path should be clearly communicated to the public,” it said. The committee also proposed that minutes of monetary policy committee meetings be published and that a bi-annual inflation report be released.

While most recommendations focused on the Reserve Bank itself, the committee also proposed the Indian government reduce its budget deficit and commit to eliminating administered prices, wages and interest rates, it said.

Fiscal Consolidation

“We will never, never again allow our fiscal consolidation to weaken,” Finance Minister Palaniappan Chidambaram said today at the World Economic Forum in Davos. “That is priority number one.”

The use of 14-day repurchase agreements should replace overnight repos as the main tool for providing central bank liquidity, the report proposed.

Higher living costs have eroded consumer demand and hurt the poor in a nation where more than 800 million people live on less than $2 per day, according to World Bank data. Food and fuel account for more than 57 percent of the CPI, the Patel Committee said.

Inflation has also become a key campaign issue ahead of elections due by May.

Prime Minister Manmohan Singh has said increases in the cost of living may be the reason his ruling Congress party lost four out of five state elections held since the beginning of November. Congress is behind in opinion polls to the main opposition Bharatiya Janata Party.

Narendra Modi, the BJP’s leader, told a party meeting on Jan. 19 that he would create a stabilization fund to combat inflation and form special courts to try those who hoard goods. The party plans to establish a real-time database of agriculture goods and prices to contain costs.

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