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MrunalExplained:UrjitPatelCommitteeonMonetaryPolicyReform

Mrunalhttp://mrunal.org

[Economy]RBIUrjitPatelCommittee:4%CPI,Nominal
Anchor,MultipleIndicator,MonetaryPolicyFramework
Reforms(Part1of2)
PostedBySupportStaffOn02/02/2014@7:48pmInEconomy|115Comments

Prologue
MonetaryPolicyreform:Wheretofocus?
#1:FocusonExchangerate
#2:FocusonMultipleindicators
#3:focusoninflation
Nominalanchor(CPI)method:Benefits/Advantagesof
Nominalanchor(CPI)method:Drawbacks/Limitations/Antiarguments
WhyTargetinflation?
NominalvsRealinterestrate
NominalAnchor(CPI):the4%Target
NominalAnchorCPI4%:WHENtoreach?
NominalAnchorCPI4%:Howtoreach?
Hawkishtrend:Whyinterestrateswillrise?
MockQuestions

Prologue
Thisarticlewontmakemuchsense,unlessyourethoroughwiththeconceptsofmonetary
policy:itsfunctions,toolsandlimitation.Somakesureyouvereadthepreviousarticle.click
me.
Place:RBIsMainAdda@Mumbai
Time:September2013
Boss:RajanhasrecentlytakenchargeasthenewgovernorofRBI.Immediatelyhesetups
threeCommittees:

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Chairman

MrunalExplained:UrjitPatelCommitteeonMonetaryPolicyReform

Occupation

Topic

Result

NewBanklicenses

Workinprogress.

Nachiket Board

Financialproducts/Financial

PublishedreportinJanuary

Mor

member

inclusion

2014.Discussedinearlierarticles.

Urjit

Deputy

Monetarypolicyframework:

PublishedreportinJan14.Thisisthe

Patel

Governor

howtostrengthenit?

topicofourarticle.

inRBI

Bimal

Retire

Jalan

Governor

UrjitPatelCommittee:Basics
Formedby:RBI(andnotfinanceministry)
Officialname:ExpertCommitteetoReviseandStrengthentheMonetaryPolicyFramework
Chairman:Dr.UrjitPatel,Dy.GovernorofRBI
EightMembers:economicsprofessors,financeexpertsetc.Theyrenotimportantfor
exams,becauseNohighprofilemembers.[maybebecauseNachikettookawayallthehigh
profilememberslikeShikhaSharmaofAxisbank,soUrjitbhaiwasleftwithonlychillar
parties.]
Overall,UrjitPatelsmainrecommendationscanbesummarizedinjustthreelines:
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@Rajan,youfightinflation.[Nominalanchor,4%CPIandeverything]
@Rajan,youfixaccountabilityinyourowngang.[formMPCCommittee,decisionsbyvoting
etc.]
@Chindu,yougivecoverfiretoRajan,whileheisfightinginflation.[fiscalconsolidation.]
Letsstartwithfirstrecommendation.
MyfirstrecommendationisthatRBImusttargetinflationonly.Nothingelsedont
Urjit

focusonincreasingemployment,dontfocusonincreasinggrowth,dontfocuson
stabilizingrupeedollarexchangerate.Justfocusononethingandonethingonly
Inflation.

Mohan Butwhyfocusoninflationonly?
Urjit

Observe.

MonetaryPolicy:Wheretofocus?
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Therearethreemainwaystoframemonetarypolicy
FocusonExchangeRate
FocusMultipleindicator(GDP,IIP,Exchangerate,inflation)
FocusonInflation(startedin80s)
Letschecktheprosandconsofeachstrategy.

#1:FocusonExchangerate
IfRBIadoptsthisstrategy/methodtoframemonetarypolicythenwhatwillhappen?
Rajanwillfirstdecideanidealtargetexchangeratesay1$=Rs.50.
Thenhelltrytoamendmonetarypolicytocontrolrupeesupplyinthemarket.
Toputthisintechnicallyincorrectexample:Imaginedollarsareapples.
PricesofapplevsRupeearedecidedbylawsofsupplyanddemand.
Atpresent1applesellsforRs.60.ButRajanwantstobringit1Apple=50rupees.What
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shouldhedo?
Rajanwilltweakhismonetarypolicytoreducethesupplyofrupeeinthemarket.Then,1
applewillsellforRs.50.(applesupplyissamebutrupeesupplyisdecreased.)
Alternatively,Rajanwillopenhisownrefrigerator(forexreserve),andputsomeapples
(dollars)forsale.Thatllalsobringdownpricesof1apple=50rupees.(becauseapplesupply
increased)

Advantages/BenefitsoftargetingExchangerate?
Pricesofimportedgoodsarekeptincheck.
Pricesofimportedcrudeoiliskeptincheck.(soindirectlyinflationiskeptincheck).
Sinceexchangeratesarekeptstablebothimportersandexporterscandecidetheirbusiness
expansionplansaccurately.(comparedtoasituationwhereexchangerateisvolatilesay
today$1=40Rs.Andtomorrow$1=60Rs.Thenitisnotgoodforbusinessdecisions.)
Clarity.TransparencyinDecisionMaking.AamJuntaacanunderstandwhatRBIistryingto
accomplishandwhetherRajanissucceedingorfailing?(iftheyevergetfreeafterwatching
cricketmatches,SaasBahuserialsand(un)realityshows.)

Disadvantages/limitationsoftargetingExchangerate?
Thismethodworkswelltocontrol(imported)fuelinflation.Butcannotcontrol(local)food
inflation.
Workswellforasmallcountries.Becausetheirpopulationissmall,theycanevenimport
foodfromIndia,Chinaandjustfocusonexportcompetitivenessinelectronicsandconsumer
goods.e.g.Singapore,Taiwanetc.
ButDoesntworkforlargecountrieslikeIndia,MexicoorBrazil.Ourpopulationissolarge,
wecannotsustainonimportedfood.Wemustbeselfreliantinfoodproduction.
Countrybecomesvulnerabletoexternalshocks.ContinuingthepreviousexampleofApplevs
Rupee
WhatifAmericanRBItightenstheirownmonetarypolicytocontrollocalAmericaninflation
(=USFedsfollowadearmoneypolicy=dollar(apple)supplyisreduced.)
ThenRajansstatisticalprojectionswillgowrong.Hellhavetomakenewadjustmentsin
RupeevsDollar(Apple)quantityinIndianmarket.
Governmentisbogus,andcauseshighfoodinflation.Result=Realinterestratesbecome
negative,Juntaawillstartinvestingmoreingold=>Goldimportincreased=>paymentshave
tobemadeinDollar.ThisalsocreatesimbalanceinsupplydemandofrupeevsDollars
(Apples).Rajanwillhavehardtimecontrollingthismess.
CountrybecomesvulnerabletoSpeculativeattacks.e.g.ForextradersinEuropeorChina
decidetohoardApples(dollars)intheirrefrigeratortocreateartificialshortageinmarket,so
laterthencanselltheirapples@higherrate.Insuchspeculativeattacks,Rajanwillhave
hardtimecontrollingsupplydemandofRupeevsdollars.Hecannotprosecutethemunder
FERA/FEMAlaws,thosetradersliveoutsidehisjurisdiction.
Outdated:DuringWW1era,mostcentralbanksusedtofollowthisExchangeratetargeting
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strategy.Buttoday,almostallbanksindevelopedcountries,haveshiftedtoinflation
targetingstrategy.OnlyfewexceptionslikeSingaporesRBIusethisstrategy.
Movingtonextmethod/strategy

#2:FocusonMultipleindicators
Atpresent,thisisthestrategyRBIusesformakingmonetarypolicy.
Undermultipleindicatormethod,Rajanwillfirstgatherinformationabout:
Indexofindustrialproduction(IIP),Consumerconfidence
Professionalforecasts(CRISIL,S&P,Moody,WorldBank)aboutGDP,inflation,
unemployment
Inflationdata:WPIminusfood,fuel.
Then,hewilldesignthemonetarypolicy(mainlyreporate),withfollowing
objectives/focuses:
Increaseemployment
IncreaseGDP
Stabilizeinflation
Stabilizeexchangerate
Soundsfairenough?Notreally!

Multipleindicatormethod:Negativepoints/Limitations
Multipleindictormethodhasnonominalanchornoactualtarget.Whatexactlyareyou
tryingtoaccomplish?BringdownWPIby5%,raiseGDPto9%..nosuchtargets.Justbol
bachhan.Thereforeineffective.
Multipleindicatorstrategyworkedwellbetween1998and2008.GDPwasgoodandinflation
waskeptincheck.Butinrecenttimes,thisstrategyisnolongerworkinginflationhas
skyrocketedandGDPisfallingdaybyday.
Since2008,Consumerpriceindexrosetodoubledigits(i.e.10%ormore)
ButRBIdoesntfocusonCPI.TheyonlyfocusonWPI(minusfoodandfuel).Result?
WPIdoesnttrackchangesintheservicesectorrelatedinflation(e.g.doctor,physiotherapist,
IT,callcenteretc.)
Servicesectorcontributesmorethan60%ofGDP.So,whenmonetarypolicyisdesigned
withoutconsideringservicesectorinflation=thenitllbeineffective.
WPIcommoditylisthasbeenrevisedinrecenttimestheyaddedicecream,oven,cricket
ball,guitarandsoon.Result?
RBIhastomakenewstatisticalcalculationabouteachofsuchbusinesarenasnumberof
peopleemployedinit,totalbankloansgiven,theircontributiontoGDPetc.
ButwhenWPIcommoditylistisrevised,RBIhastocalculatenewstatisticalprojections=
problem.Policydoesntgiveeffectiveresultinthemeantime.
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EvenifRajanmakesbestpolicy,itsImpactwillbeseenafteralagof34quarters(i.e.nine
totwelvemonth).Why?WealreadylearnedthelimitationsofMonetarypolicyinadeveloping
country,thepastarticle.Clickme
Sincethisstrategydoesnthaveaclearcuttransparenttargets,itbecomesvulnerableto
variouspressuregroups.Forexample
Pressure
group

informallyforcesRajanto:
PleaseincreaseSLRratio.Thatwaygovernmentisabletosellmoreofits
securitiestothebanksandarrangecashfrommoreschemestoincrease

Chindu

employmentafterallthatswhatyouwantincreaseemployment!
Secondly,pleaseincreasethequotaforwomenunderPrioritysectorlending
becauseRahulbabahasbeenadvocatingwomenempowermenteverywhere,
including@ArnabGoswamisinterview.

Exporters/ RajanBhai,pleasetweakyourmonetarypolicyinsuchwaythat$1=becomes
IT

1000rupees,thenweearnmorerupeeswhileexportinggoodsnservices

companies abroad.
Importers

Pleasedesignyourmonetarypolicyinsuchwaythat$1=Rs.1.thenweveto
spendlessrupeeswhileimportingstufffromabroad.
PleasedecreasePrioritysectorlending,CRRandSLRthatwaymoremoneyis

FICCI

leftforbusinessloansforcorporategiants.

Bankers

Maaibaap,pleasereducePSLtargets,SLR,CRRandRepo,thatwaymore
moneyisleftwithus,andwecanlendittomiddleclassandbusinessmen.

Therefore,UrjitrecommendsRajantodumpthismultipleindicatormethod.
Okboss.SofarIvelearnedfollowing:
Monetarypolicyshouldnotfocusonexchangeratebecauseourcountryisverylarge,
Mohan

unlikeSingaporeandTaiwan.
Monetarypolicyshouldnotfocusonmultipleindicatorapproach,becauseofthe
limitationswejustsawinaboveparagraph.
Thenwhatisyoursolution?

Urjit

Simple.Focusoninflation

#3:focusoninflation

InthisstrategyRajanwilldecideaNominalAnchorsayCPItomonitorinflation.Thenhell
fixaninflationtargetsay26%andadjusthismonetarypolicysothatinflationremains
withinthatrange.

Nominalanchor(CPI)method:Benefits/Advantagesof
OnceRajansetsaCPItarget.Noonecaninfluencehimorputinformalpressurebeit
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Chindu,Exporters,Importers,FICCI,Mallya,AmbaniorBankerscannotinfluenceRajans
policy.BecauseRajan
Easytotrackprogress.BecauseCPIdatareleasedaftereverytwelvedays.
CentralbanksinalladvancedeconomiesandEmergingmarketeconomieshaveadoptedthis
method.(ExceptIndiaandChina).
Itbringstransparency.EvenaamjuntaacanunderstandwhatRBIspolicyisandwhetherits
yieldingresultornot?Becausethereisonlytargettomonitor=CPI.
PreviousCommitteeshavealsodirectly/indirectlyrecommendedforthissystem.For
example:
year Committee

Chairman

2007 MumbaiasInternationalFinanceCenter

PercyMistry

2009 Financialsectorreform

RajantheBosshimself

2013 FinancialSectorLegislativeReformsCommission(FSLRC) BNSriKrishna

Nominalanchor(CPI)method:
Drawbacks/Limitations/Antiarguments
Mohan
Urjit

Holdonasecond.Youretryingtopaintaveryrosypicture.ButifRajansmonetary
policytriestocontrolCPI,itllhavemanyproblems!
Suchas??
InCPIindexmorethan50%weightageisgiventofoodandfuelcomponents.
Foodprices=dependonmonsoonandblackmarketers.Rajanhasabsolutelyzero

Mohan controloverthis.
Fuel/crudeoilprices=dependonexternalfactorsandRupeeDollarexchangerate.
Rajandoesnthavesufficientforexreservestocontrolrupeedollarexchangeratein
themannerhewants(e.g.1$=50rupeesandnot1$=60Rs.)
Youreright.Butundermultipleindicatormethod,RajanfocusesonWPI(minusfood
andfuelinflation).
Urjit

Thatswhyhispolicyhasremainedineffectiveincontrollinginflation.Becausehe
alwaysignoredfoodandfuelinflation.
Infact,WemustfocusonCPIfortheverysamereasonbecauseitgive>50%
weightagetothefoodandfuelinflation.

Mohan
Urjit

Pointtaken.ButinIndia,wehavethreeCPIs:Urban,RuralandCombinedifwetry
tocontrolallthreeofthem,then..
Noproblem.WemustfocusonlyonCPI(Combined).Itsdataisreleased@every12
days.Veryeasytomonitor,trackspricemovementalloverIndia.

Mohan Yabutstill,Itsdataisnotaccurateand.
yaarifyoustarttofindfaultineverything(likeaTheH****columnist),.thenonly
Urjit

Godcanhelpyou.FidelCastroandCheGuevaracannotfixIndiasinflationproblem.

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ThisonlygetsfixedfrominsidetheRBI!
Mohan

ButevenifRajanfocusesonthisNominalAnchor(CPI),stilltherewillbealagof68
monthsbeforeitsimpactsareseen.
Brother,nomatterwhichmethodweusetherewillbelagof68monthsbeforeits
impactisseenoninflation@groundlevel.

Urjit

Becausewearenotadevelopedcountry,weareadevelopingcountry.
Wevealreadylearnedthislimitationofmonetarypolicyindevelopingcountries.Click
me.
Okonelastobstacle.GovernmentsownpolicytofightCPI.Forexample,whenever

Mohan

pricesofsugar,onionorpulsesgetveryhigh,thegovernmentarbitrarilyputsexport
banonthosecommodities,startimportingthemfromxyzcountry,startsdistributing
them@subsidizedratesinvariouscities.

Urjit

So?
SoRajanmaybedesignedhispolicytofightCPIusingabcstatisticalprojectionsbut

Mohan

atrandom,thegovernmentwilldoxyzpolicyonitsowntofightinflation=Rajans
statisticalprojectionswillbecomewrongandhismonetarypolicywillbecome
#EPIFAIL.

Urjit

ForthisIrecommendbettercoordinationanddatasharingbetweenGovernmentof
IndiaandRBI,regardinginflationcontrol.

WhyTargetinflation?

Imstillnotclear.WhyshouldRajanonlyfocusoninflation(CPI).Otherthingsare
Mohan alsoimportantlikeGDP,IIP,employment,investment,exchangerates.whyfocus
onCPIonly,andignoreeverythingelse?
Urjit

letmeexplain:

petrolandonionprices,hardshiptomiddleclass=thoseareclichdpoints.Letslearnsome
newpoints.
Inrecentyears,IndiasinflationhasbeenhighestamongallG20countries.
Indiasinflationhasbeenhigherthanitstradecompetitors.

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CPI

2008 2012

World

Brazil

China

<3

India

>10

S.Africa 11

Russia 14

Fromabovetable,youcanseethat
Between2008to2012China,SouthAfricaandRussiahavedrasticallyreducedtheir
inflation.OnlyIndiaisthe#EPICFAILcountrywhereinflationhasincreasedinsteadof
decreasing!
Higherinflation=realinterestratesdecreased=>makespeoplebuymore
gold=>CAD=>rupeeweaken=>petrolexpensive=>everythingexpensive=>everymore
inflation=viciouscycle.
Mohan

Whoa,whoa,whoamanslowdown.Whatisrealinterestrate?Howdoesitaffect
economy?

NominalvsRealinterestrate
Urjit

SupposeIve100rupees.Butinsteadofbuyingonions,Iputthismoneyinasavings
account.

Observewhathappenswithmypurchasingpower:
OnionRs./kg Money HowmuchcanyouBuy?
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1stJan 20

100

5kg

31stDec 100

104

~1kg

Meaning,althoughbankincreasedyourmoneyfromRs.100to104,butyoucanbuyveryless
onions.Therefore,wemustnotfocusonnominalinterestratei.e.4%butonrealinterest
rate.
NominalInterest

CPI

RealRateofInterest=(Nominal

Rate

(Inflation)

Inflation)

4.00%

11%

7%

Fixeddeposit 9.00%

11%

2%

Bankdeposit
Savings
account

Fromabovetable,youcanseeBanksinIndiaoffernegativerealinterest.Therefore,people
prefertoinvestingold,insteadofputtingmoneyinbankaccounts.
Result:
Excessivegoldimport=>Currentaccountdeficitincreased=>RupeeWeaken=>Petrol/diesel
expensive=>evenmoreinflation.Thisbecomesaviciouscyclewhereyoucannotfind
whetherhencamefirstortheeggcamefirst?
Whenpeopleinvestmoneyingold,insteadofputtingitinbank=>businessmengetless
loans=>lessexpansion=>lessjobs=>lessgrowthinGDP.
NowifyoucompareIndiavs[China,Russia,SouthAfrica].Youcanseetheirinflationis
low=>realinterestratewouldbehigher=>peopleinvestlessingold=>moremoneyflows
towardsbanks=>businessloans=>higherGDP,higherIIP(indexofindustrialproduction).

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Urjit

MrunalExplained:UrjitPatelCommitteeonMonetaryPolicyReform

Inotherwords,whenRajanframesmonetarypolicy,heshouldonlyfightagainst
inflationthenlowGDP,lowIIPwillbefixedautomatically.

Mohan fairenough.

NominalAnchor(CPI):the4%Target
Okfarwevelearned:
WhenRajanframesmonetarypolicy
Hemustfocusonfightinginflationonly.
Tofightinflation,hemustfocusonCPI.
Nowtheproblem?WhatshouldbehisexactCPItarget?4%,5%.0%,50%??
Thisiseasy.Rajanshoulddesignmonetarypolicyinsuchway,thatCPIis50%.If
Mohan bottleofdesiliquorwassold@100Rs.in2010,thenin2014itspriceshouldreduce
toRs.50only.ThenMaujaahiMaujaa.
Urjit

Ihatetobreakyourspirit,butsuchdeflationarytrendisnotgoodforeconomy.

Everybusinesshasfixedcostofproductionminimumlightbill,phonebill,officerent,staff
salaryetc.So,ifpriceskeepfallingandfalling,thenbusinessmanwillsufferlosses.Hehasno
motivationtoexpandbusiness.Hewantstocutdownhisproductioncosts,byfiringsomeof
theemployees=lessnewjobscreated=unemployment=socialunrest.
Ifpricesofeverythingfallthencustomduty,VAT,exciseduty,servicetaxtheircollection
willalsodecrease.Thengovernmenthaslessmoneytospendoneducation,healthcare,
socialsector,defense,lawandorder=poverty,disease,crime.
Mohan
Urjit

Thenwhatshouldbetheminimumtarget?Whatshouldbethelowerlimitof
inflation?
Minimum2%inflationisnecessaryinanyeconomy.

Mohan Thenwhatshouldbethemaximumlimitforinflation/CPI?
Iveanalyzeddatafromvariouscountries.WhenCPIgetshigherthan6.2%,it
Urjit

negativelyaffectsGDPandemployment.ThereforeRajanshouldensureCPIinflation
doesntcrossmorethan6%.

Mohan Ok,minimum2%andmaximum6%.
RightRBIshouldtrytogetCPIinflation@4%withbandof+/2%.
Urjit

meaning42=2%minimum
and4+2=6%maximum

Mohan Butwhygivethis2%band?Whynotjustsay4%isourtarget?
Becauseinreallife,itisnotpossibletogetinflationcontrolled@exactly4%level.
Therewillbeunanticipatedpriceshocksinfoodandfuelitems,wars,faminesand
Urjit

naturaldisasters.
Therefore,Rajanshouldbegivensomeroomtoaccommodatesuchshocksthats

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why26%target.
Besides,theRBIsofothercountriesalsousesimilarbandmethod:observe
CentralBankof CPItargetundertheirmonetarypolicy
Mexico

24%

SouthAfrica

36%

Israel

13%

Chile

24%

So,itsatriedandtestedmethod.weshouldfollowthesame.

NominalAnchorCPI4%:WHENtoreach?
OksofarIvelearned:
Mohan UrjitPatelCommitteewantstostrengthenmonetarypolicyframework
YouinsistRBItofightinflationonly.
YouevengaveRajanatarget:4%CPI(Combined),with+/2%band
Urjit

Thatiscorrect.
well,Yourrecommendationisambitious,butunrealistic.IrepeatagainThereare

Mohan manyfactorsoutsideRajanscontrollikemonsoonandblackmarketers.Idontthink
Rajancaneverbringdowninflationto4%level.
Urjit

Itispossible.LetmegiveyouthecasestudyofChile.

During90s,ChilewasfacingCPIinflationashighas25%.
Butintheearly2000s,theRBIofChilemadethetarget3%CPI(With+/1%band)=24%
CPI
Nowobservethefollowinggraphparticularlythegreenbandbetween2002to2006.Youcan
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seeChilesRBIhassuccessfullymanagedtocontaininflationwithinthat24%level.
Urjitrecommendedfollowingtimeframe:

0month(i.e.whenUrjitwas
makingreport)

CPIis~10%

Within12months

RBIshouldreduceCPIto8%

Within24months

RBIshouldreduceCPIto6%
Justtrytomaintaininflationwithinthe26%range.(i.e.

Then

4%with+/2%band)

Inshort:0/12/24(months)=>10/8/6(CPI)

NominalAnchorCPI4%:Howtoreach?
Mohan Alright.IfChilecandoit,wecanalsodoit.ButHOW?
Urjit

Usingthesametoolsavailableinthepresentmonetarypolicyframework.
Especiallythepolicyrate.

Mohan Whatispolicyrate?
Urjit

ReporateunderLiquidityadjustmentfacility(LAF)=thatsourpolicyrate.
Andreverserepo(RR)=Repominus1%
MSF=Repo+plus1%

Urjit

^Thissystemisfine.IrecommendthatRajanshouldcontinuewithit.
RBIshouldnotchangethis+/1%spreadbetweenRRRepoMSF.(unlessin
extremesituation)becauseunpredictablepolicymaking=notgoodforbanking

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sectorsownbusinessplansandtacticalprojections.

Hawkishtrend:Whyinterestrateswillrise?
OksofarIvelearned:
UrjitPatelCommitteewantstostrengthenmonetarypolicyframework
Mohan YouinsistRBItofightinflationonly.
YouevengaveRajanatarget:4%CPI(Combined),with+/2%band
YouevengaveRajanatimeframe:0/12/24(months)=>10/8/6(CPI)
YouevengaveRajanthefiringstrategy:fightinflationviaPolicyrate(RepoRate)
Urjit

Thatiscorrect.
Butthenwhatsthenewstorymyfriend?Alltheseyears,RBIhastriedtofight

Mohan inflationbyusingReporateasitspolicyrate.Butithasfailedtoyieldanypositive
result.Whatmakesyouthinkreporatecanfixourinflationproblems?
Urjit

SwamiVivekanandhassaidAimhigher.Onthesamelogic,IrecommendRepo
RateshouldbekepthigherthanCPI.Thenitllfixtheproblem.

Observe.
Atpresent
Repo

8%

CPI

~10%

Difference(RepoMINUSCPI) 2
YoucanseeReporateislowerthanCPI.Thatswhyitsineffective.Inthepreviousarticleon
monetarypolicy,welearnedthat
MonetarypolicyTool HowtoFightinflation? Howtofightdeflation?
Reporate

Increasereporate

Decreasereporate.

Therefore,tofightinflationreporateMUSTbeincreased.UrjitPatelrecommendsthatRepo
rateshouldbeincreasedsomuchthatitshigherthanCPI.
At
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present UrjitPatelsrecommendation
ShouldbehigherthanCPI.HereCPI=10,soletskeep

Repo

8%

CPI

~10%

~10

(1110)=+1

Difference(RepoMINUS
CPI)

Repo@11%

Inotherwords,UrjitPatelrecommendsthatdifferencebetweenPolicyrate(Reporate)and
CPIshouldbepositive,OnlythenPolicyratecanfightinflation.
Whatwillbetheconsequencesofhighreporate?
BanksborrowlessfromRBI(Becausetheyvetopaymoreinterestrate)
Bankswillincreasetheirloaninterestrates(becausetheyvelessnewmoneyandstillwant
tokeepprofitmarginsame)
Lessbusinessexpansion(becauselesspeopletakeloans,duetohigherinterestrate)
Lessnewjobscreated
Lessincome
Lessdemand
SellerswillreducePricesofgoodsandservices,toattractandretaincustomers.=inflation
reduced.
Mohan
Urjit

Waitwaitwait.UrjitPatel,youreahawkishperson,apersonwhobelievesinflation
canbefoughtbyincreasingtheinterestrates.
Sowhat?
SomanRajanraisesReporate=>SBIincreasesloaninterestrates=>harderto
borrowforbusinessmen=>lessbusinessexpansion=>lessnewjobs=>deflationary

Mohan

trend=>thiswillhurtourGDP.
CRISIL,Moodyandotherexpertshavemadestatisticalprojectionsthatevenin
2015,ourCPIwillbe~8.5%.Sobyyourlogic,RajanshouldkeepRepo@9%.Itwill
killthegrowth!
Theoreticallyyoureright.HighinterestratesarenotconductiveforhigherGDP
growth.
ButIndianinflationhasbecomesohigh,thatextremestepsarenecessary.

Urjit

Besides,theRBIsofAustralia,Canada,S.Africa,Mexico,Brazil,Israelallhave
takensamemeasureinpast.
Wheninflationbecameveryhigh,theyraisedreporatetolevelhigherthaninflation.
Onlythenproblemwasfixed.
Whateverman.ImgoingtowriteacolumninTheH****tocriticizeyouthatIfUrjit

Mohan PatelCommitteesreportisimplemented,interestrateswillriseandgrowthwillbe
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killed.(PackshislaptopandPreparestoleave.)
Urjit

WAIT!Pictureabhibaakihaimeredost.OverallImadethreeimportant
recommendations.Inthisarticleweonlylearnedthefirstone:

@RBIfightinflation
Target=4%CPI,+/2%Band[=controlinflationin26%range.]
Tool=Repoaspolicyrate,+/1%spreadinRRRepoMSF,
Timelimit:0/12/24(months)=10/8/6%(CPI)
Strategy=keeprepohigherthanCPI.
@Chindu,givecoverfiretoRajan,whileheisfightinginflation(=innextarticleclickme)
@Rajanfixaccountabilityinyourgang.(=innextarticleclickme)

MockQuestions
Incorrectstatement

Nominalinterestratedoesnttakeinflationintoaccount.
RealinterestratedoesnttakeNominalinterestrateintoaccount.
BothAandB
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NeitherAnorB
WhatdoyouunderstandbyRealinterestrate?
Nominalinterestrateplusinflation
Nominalinterestrateminusinflation
Nominalinterestratemultipliedwithinflation
Noneofabove.
Inafuturisticsociety,ifRealinterestratebecameapositivenumber,whichofthe
followingismostlikelytobecorrect?
Fiscaldeficitincreasedattheexpenseofcurrentaccountdeficit.
Peoplehavestartedputtingtheirentiresavingsintogold.
RBIandGovernmentfailedincombatinginflation.
RBIandgovernmentsuccessfullymanagedtobringdowninflationbelowthenominalinterest
offeredinbanks.
UrjitPatelCommitteehasobservedthat
CPIlowerthan2%isgoodforeconomybutCPIhigherthan6%isbadforeconomy
CPIlowerthan2%facilitatesgrowthbutCPIhigherthan6%reducesemployment.
CPIlowerthan2%andhigherthan6%,arebadforGDPandemployment.
Noneofabove.
UrjitPatelCommitteehasrecommendedthat
RBIshouldcontinuewithmultipleindicatormethodtoframemonetarypolicy,whiletargeting
4%inflation.
RBIshouldignorefuel,foodandservicesectorinflationandfocusoncoreinflationonly.
RBIshouldframemonetarypolicywhilekeepingCPIasthenominalanchor.
Noneofabove.
UrjitPatelrecommendsRBIto:
Bringdownconsumerpriceindexinflationto6%withinnexttwelvemonths.
Switchitsfocusfrommultipleindicatorstoexchangeratestabilization
bothAandB
NeitherAnorB.
ToCombatinflation,UrjitPatelCommitteehasrecommendedRBIto:
KeepReporatelowerthanCPI.
KeepReversereporatehigherthanMSF.
KeepthevalueofReversereporatebetweenReporateandMSF.
NoneofAbove.
Q8.IfRBIframesmonetarypolicywithprimaryobjectiveofstabilizingthe
exchangerate,whatwillbetheconsequences?
Countrybecomesvulnerabletoshocksemanatingfromthecountrytowhichitscurrencyis
pegged.
Countrybecomesimmunetospeculativeattacksinforextradingmarket.
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Importedinflationwillbekeptincheck.
Choices
Only1and2
Only2and3
Only1and3
All1,2and3.
Q9.WhataretherecommendationsofUrjitPatelCommittee?
Inationshouldbethenominalanchorforthemonetarypolicyframework.
RBIshouldadoptthenewCPI(rural)asthemeasureofthenominalanchorforpolicy
communication.
WPIinationshouldbesetat4percentwithabandof+/2
Answerchoices
Only1and2
Only2and3
Only1and3
Only1
Q10.Matchthefollowing:
Hawk
Bull

Purchasessecuritiesundertheassumptionthattheycanbesoldlateratahigher
price.
Believesthataparticularstockorthemarketasawhole,isheadedforafallinprices.

Bear Favorsrelativelyhighinterestratesinordertokeepinflationincheck.

Favorsrelativelylowinterestratesinordertokeepdeflationincheck.

Answerchoices
Options I II III
A

12 3

41 2

31 2

32 1

Q11.Matchfollowing
NachiketMor NominalAnchorMethodtoframeMonetaryPolicy
UrjitPatel

FinancialSectorLegislativeReforms

BNSriKrishna GovernanceofBoardsofBanksinIndia.
P.J.Nayak

Financialproductsforsmallbusinessmen.

Statebackwardnessindex

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Answerchoices
Options I II III IV
A

51 2 3

31 3 5

41 2 5

41 2 3

Mains/interviewtypequestions,oncewefinishremainingrecommendationsofthe
committeeinnextarticle.
MCQhints:
incorrectstatementisB
technicalformulaisbitdifferentbuthereoptB
lastone
<2and>6bothbad.
secondlast
neither
none
secondstatementiswrong.
onlyfirststatementisright
hawkinterest,bullwillrisebearswillfall
Nachiproducts,UrjitNominal,BNreforms,NayakBoard.
VisitMrunal.org/EconomyFormoreonMoney,Banking,Finance,TaxationandEconomy.

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