Central banking remains desirable in India because it anchors price stability, safeguards financial stability, and mitigates crisis dynamics through lender-of-last-resort functions while shaping expectations in a structurally supply-sensitive economy. India’s post-2016 flexible inflation targeting (FIT) regime, CPI anchoring, and a statutory Monetary Policy Committee (MPC) have institutionalized a rule-based, credible framework, improving macro predictability and policy transmission in the presence of recurrent food and fuel shocks
Desirability
- The FIT framework, introduced via the 2016 amendment to the RBI Act following a 2015 Monetary Policy Framework Agreement, codified price stability as the primary objective while permitting flexibility for growth and supply shocks, which is essential given India’s high food weight and external volatility.
- Empirical assessments suggest reduced inflation volatility and improved policy credibility under FIT, with the 4% target and a ±2% band balancing stabilization and growth needs in an emerging-market context.
Autonomy and independence
- The 2016 statutory changes created a six-member MPC with three RBI officials and three government-appointed externals, defined meeting frequency, forward publication, and report requirements upon target breaches, thereby formalizing operational autonomy and decision transparency.
- Earlier autonomy-enhancing reforms included the 1997 agreement ending automatic monetization of deficits by replacing ad hoc Treasury Bills with Ways and Means Advances (WMA), a shift that curtailed fiscal dominance and strengthened RBI’s capacity to run independent monetary policy.
Credibility
- RBI’s credibility is reinforced by a clear nominal anchor (headline CPI at 4% with a ±2% band), periodic target review by the government in consultation with RBI under Section 45ZA, and structured communications through MPC resolutions and Monetary Policy Reports.
- International and domestic studies argue that FIT improved anchoring of expectations and transmission, with design features tailored to India’s heterogeneities, including survey-based inputs and tolerance for supply shocks.
Accommodative and neutral stances of RBI
A central bank adopts an accommodative stance when it wants to stimulate economic growth, often during periods of low inflation and weak growth, by lowering interest rates and increasing the money supply. Conversely, a neutral stance allows flexibility to raise, reduce, or maintain interest rates as economic conditions and inflation outlooks evolve, without prioritizing either growth or inflation control. The choice depends on the prevailing macroeconomic environment, with an accommodative stance signaling support for growth and a neutral stance indicating adaptability to changing conditions.
Accountability and transparency
- The amended RBI Act mandates MPC processes, meeting schedules, and publication norms, including formal explanations to government if inflation remains outside the band for three consecutive quarters, enhancing accountability in a democratic setting.
- Policy communication practices—forward guidance, inflation projections, and repo decisions explicitly tied to the FIT mandate—have increased transparency and predictability, aligning with global norms while retaining domestic specificity.
Conflict with fiscal policies
- Post-liberalisation reforms sought to reduce fiscal dominance, notably through the 1997 WMA framework and the FRBM Act (2003) aimed at constraining deficits and debt, thus lowering pressures for debt monetization and preserving monetary independence.
- The NK Singh FRBM Review (2016–17) recommended a debt anchor of 60% of GDP (40% Centre, 20% States) with glide paths for fiscal and revenue deficits, seeking a durable rules-based environment to minimize policy conflict and improve macro stability.
Indian case references
- FIT architecture: Government–RBI agreement in 2015 and 2016 RBI Act amendment set CPI-based 4% target with 2–6% band, established MPC composition and tenure rules, minimum meetings, and breach-reporting obligations, institutionalizing modern monetary governance.
- Post-1991 fiscal reforms: The 1997 termination of ad hoc T-bills and shift to WMA limited automatic monetization, with specific interest-rate and limit mechanics replacing open-ended financing, a cornerstone for RBI operational space and anti-inflation credibility.
- FRBM evolution: The FRBM framework progressed from initial deficit curbs to NK Singh Committee’s debt-anchor approach and updated glide paths, aiming to reinforce inter-temporal budget constraints and reduce spillovers that can force monetary accommodation.
Fiscal-monetary coordination
- During stress episodes (global shocks, commodity spikes), FIT’s flexibility enables temporary tolerance for deviations while preserving the medium-term 4% objective, contingent on fiscal conduct consistent with the FRBM roadmap to avoid reassertion of fiscal dominance.
- Contemporary commentary underscores inflation control as RBI’s priority within the amended mandate, even as coordination persists with fiscal authorities to navigate growth–stability trade-offs without compromising autonomy or credibility.
Conclusion
India’s central banking reforms—FIT-based statutory clarity, MPC governance, termination of automatic monetization, and FRBM-based fiscal rules—collectively enhance the desirability, autonomy, credibility, accountability, and transparency of monetary policy, while providing structured mechanisms to manage fiscal-monetary frictions. Sustaining these gains requires adherence to debt and deficit anchors, disciplined recourse to WMA, and continued transparent communication within the FIT framework to keep expectations anchored amid recurrent supply shocks.
CAIIB –Central Banking (elective) –‘Model A’ related articles
