The key implication of this new CPI-based inflation targeting framework is that interest rates in India will remain higher for longer, says Nomura
The Urjit Patel Committee appointed by the Reserve Bank of India (RBI) has recommended that headline consumer price index (CPI) inflation should be the nominal anchor for monetary policy. The Committee says this is to revise and strengthen the monetary policy framework in India. Instead of the current multiple indicator approach, inflation should be the nominal anchor and this should be communicated without ambiguity, the Committee has said.
“The key implication of this new CPI-based inflation targeting framework is that interest rates in India will remain higher for longer,” says Nomura in a research report. "When inflation is above the nominal anchor, the real policy rate is expected, on average, to be positive," it said.
Nomura said, “Real policy rates in India are very negative and unless CPI inflation moderates, policy rates will move higher. While CPI inflation should moderate as vegetable prices ease, we expect headline CPI inflation to remain elevated at above 9% in 2014 as a result of the upswing in rural wages and elevated inflation expectations.”
Against this backdrop, Nomura sticks to its call of a cumulative 50bp hike in the repo rate in first half of 2014 including a 25bp hike at the 28th January monetary policy meeting.
The recommendations of the Urjit Patel Committee includes setting up of a five-member monetary policy committee (MPC) consisting of the RBI governor, deputy governor and executive director in charge of monetary policy and two external members chosen by the central bank. Each member will have one vote and the monetary policy outcome will be decided by majority vote. Further, the MPC will be accountable for any failure to establish and achieve the nominal anchor. Minutes of the proceedings of the MPC are to be released with a lag of two weeks. The RBI will also publish a bi-annual inflation report.
On inflation targets, the Urjit Patel Committee report has recommended that the ultimate target for CPI inflation should be set at 4% with a band of plus/ minus 2%. However, given the currently elevated inflation levels the committee recommends a transitional phase to the ultimate target zone, from the current level of 10% to 8% over a period not exceeding the next 12 months. Further, CPI inflation should reach 6% over a period not exceeding the next 24-month period before formally adopting the recommended target.
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