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September 24, 2010

RBI – Sole Objective – to control Inflation

The Preamble of RBI describes its function as to regulate issue of Bank Notes and keeping of reserves with a view to securing monetary stability in the country.
Role of RBI
1. Bank of Issue: Issues Bank notes of all denominations
2. Acts as Government banker & advisor, agent to Central and State Governments.
3. Controller of Credit
4. Custodian of Foreign Reserves
5. Supervisory functions : settles disputes arising among other banks under its ambit.
Inflation – A concern
Inflation is a grave concern, given the vast disparity between the rich and poor. Skyrocketing inflation robs the poor, and hurts others.
RBI follows a multiple indicator approach to arrive at its goals of growth, price and financial stability- rather than targeting inflation alone. Rbis OBJECTIVES R often conflicting with each other>>> It looks confused, ineffective and does not effectively tackle inflation but effectively stunts the growth pattern of the economy.
RBI should clear itself from this confusion and control inflation while maintaining growth. It should be reactive rather than proactive, as monetary policy is most effective when it is forward-looking. RBI’s autonomy should not be compromised either in fact or in perception
Why it is not possible?
Constraints imposed by the political system pulls down autonomy of RBI. Transparency is the best example.
RBI’s decision to strip Dr KC Chakrabarty of important portfolios. Monetary policy being dictated by a powerful governor/finance ministry & Subbaraos decision to reverse an increase in pension for RBI retirees.
Some have even mockingly dubbed RBI as the finance ministry’s ‘department of monetary policy execution’.
Solution: Operational Independence
1. RBI should seek government approval only on matters where the RBI Act (1934) calls for such approval. It should articulate need for changes in the Act. Autonomy is never given, it is earned and taken.
2. There should be a clear paradigm to adopt. By all means, let the RBI's fight against inflation continue. The US Fed Reserve, which is the RBI's model, does not have to resort to CRR. control is through the price of money i.e, interest rate and not the quantity. The Fed does not sequester resources of the banking system by raising CRR for it has zero CRR. Even if the Fed's monetarist model is followed, one has to allow borrowers to get credit at least at a price. Both quantity and price cannot be controlled at the same time, which is what the RBI is doing.

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