India in depth: Changing recipe of monetary sauce

Oct 15 2013, 17:25 IST
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In question: Monetary policy of India's central bank In question: Monetary policy of India's central bank

embrace a formal inflation-targeting regime. But it shouldn't be in a hurry to go down that route. Since the 1997 financial crisis, most developing countries in Asia have adopted arrangements whereby the central bank is given an inflation goal by the government or parliament, and told to focus its efforts on achieving it. By and large, inflation targeting has worked -- but not everywhere, and not always. For example, the Bank of Thailand steadily raised interest rates in 2006 in an attempt to rein in inflation. The hot money that poured eventually prompted the country to impose capital controls. Thai assets were subsequently walloped.

Before India can migrate to inflation targeting, the government must first prune its permanently elevated budget deficit, so that it's able to use fiscal policy to dial economic output up and down. Still, there is no doubt that too many ingredients are spoiling the consistency of India's monetary broth. Even if Rajan can't adopt a simpler recipe overnight, he can enhance the anti-inflation flavour of his interest-rate concoction.

Andy Mukherjee

The author is a columinst currently writing for Reuters' Breakingviews

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