Muneesh Kapur

Monetary Transmission Mechanism in India: A Quarterly Model

This paper examines monetary transmission mechanism for India in the context of a small macro model using quarterly data. Given the volatility emanating from the agricultural sector, the paper models both overall growth and overall inflation as well as non-agricultural growth and non-food manufactured products inflation, i.e., components stripped of the influence from the agricultural sector and which are more amenable to monetary actions. Model simulations for a one-quarter 100 bps increase in the nominal effective policy rate show that the peak effect on non-agricultural growth is almost 40 bps with a lag of 2 quarters and that on non-food manufactured products inflation is 25 bps with a lag of 5 quarters. Therefore, the interest rate channel is effective in the Indian context and the magnitude of the impact on growth and inflation is comparable to that in major advanced and emerging economies; however, the evidence for both India and other countries suggest that the impact of monetary policy actions on inflation is modest and subject to lags. The results are sensitive to alternative measures of real interest rate. Despite the monetary tightening by Reserve Bank of India during 2010 and 2011, inflation remained high and this could be attributed to the structural component of food inflation as well as the surge in international commodity prices beginning the second half of 2010 and continuing into the first half of 2011.

A Monetary Policy Model Without Money for India

A New Keynesian model estimated for India yields valuable insights. Aggregate demand reacts to interest rate changes with a lag of at least three quarters, with inflation taking seven quarters to respond. Inflation is inertial and persistent when it sets in, irrespective of the source. Exchange rate pass-through to domestic inflation is low. Inflation turns out to be the dominant focus of monetary policy, accompanied by a strong commitment to the stabilization of output. Recent policy actions have raised the effective policy rate, but the estimated neutral policy rate suggests some further tightening to normalize the policy stance.

Liberalization and Regulation of Capital Flows: Lessons for Emerging Market Economies

Capital flows to emerging market economies (EMEs) have been characterized by high volatility since the 1980s. In recent years (especially since 2003), although gross as well as net capital flows to the EMEs have increased, they could not be absorbed domestically. Overall, savings have flowed uphill from EMEs to advanced economies, challenging the conventional view that capital flows to EMEs are always beneficial through augmentation of their resources leading to greater investment. Full capital account liberalization can impart avoidable volatility and have an adverse impact on growth prospects of EMEs. Available evidence is strongly in favor of a calibrated and well-sequenced approach to opening up the capital account and its active management, along with complementary reforms in other sectors. Greater caution is needed in the liberalization of debt flows. Despite much advice to the contrary, most EMEs manage their capital accounts actively to cushion their economies from undue volatility, including interventions in the foreign exchange markets accompanied by sterilization. Sound macroeconomic and financial policiesaccompanied by prudent capital account management, greater exchange rate flexibility, purposive use of prudential regulation, and continued financial market development practiced by most Asian EMEs over the past decadehave cushioned their economies from the current global financial crisis that started in 2007. They have successfully achieved a virtuous circle of continuing growth, low and stable inflation, and financial stability. How these elements can be best combined will depend on the country and on the period : There is no one size fits all. Such a discretionary approach does put a great premium on the skill of policymakers and can run the risk of markets perceiving central bank actions becoming uncomfortably unpredictable. Such risk is mitigated by a record of successful management.

Alternative Monetary Policy Rules for India

This paper empirically evaluates the operational performance of the McCallum rule, the Taylor rule and hybrid rules in India over the period 1996-2011 using quarterly data, with a view to analytically informing the conduct of monetary policy. The results show that forward-looking formulations of both rules and their hybrid version - setting a nominal output growth objective for monetary policy with an interest rate instrument - outperform contemporaneous and backward-looking specifications, especially when targeting core components of GDP and inflation, and combine the best parts of efficiency and discretion.

India's Recent Macroeconomic Performance: An Assessment and Way Forward

The sustained high growth in an environment of macroeconomic and financial stability—recorded by the Indian economy prior to the North Atlantic financial crisis (NAFC) has suffered a setback. While the macroeconomic policy response after the NAFC was admirably rapid, there was overshooting of the stimulus, and its withdrawal was gradual. The stimulus measures led to high growth, averaging 9%, during 2009–11, but also sowed the seeds for inflationary and balance of payments pressures, necessitating the subsequent moderation in domestic demand and growth. The domestic slowdown was then further exacerbated by domestic policy bottlenecks. Appropriate policies in regard to domestic oil prices and fiscal consolidation will make more resources available to the private sector and contribute to the recovery of private sector investment. Fiscal consolidation would also facilitate a reduction in inflation, which would then have a moderating impact on gold imports and a favorable impact on the real exchange rate, exports and current account deficit. Given the growth and inflation expectations, interest rates in India can be expected to remain above those in advanced economies, even when we move away from the present aberrations of near zero interest rates in the major advanced economies; therefore, a prudent approach with regard to the opening up of debt flows to foreign investors needs to be pursued

Monetary Policy Coordination and the Role of Central Banks

The unconventional monetary policies (UMPs) pursued by the advanced economies (AEs) have posed macroeconomic challenges for the emerging market economies (EMEs) through volatile capital flows and exchange rates. AE central banks need to acknowledge and appreciate the spillovers resulting from such UMPs. Central banks of the AEs, who have set up standing mutual swap facilities, should explore similar arrangements with other significant EMEs with appropriate risk mitigation measures. These initiatives could do much to actually curb volatility in global financial markets and hence in capital flows to EMEs, thus obviating the need for defensive policy actions on the part of EMEs.

A monetary policy model for India

A New Keynesian model estimated for India yields valuable insights. Aggregate demand reacts to interest rate changes with a lag of three quarters, while inflation takes four quarters to respond to demand conditions. Inflation thus responds to monetary policy actions with a lag of seven quarters. Inflation is inertial and persistent when it sets in, irrespective of the source. Exchange rate pass-through to domestic inflation is low. Inflation turns out to be the dominant focus of monetary policy, accompanied by a strong commitment to the stabilization of output.

Pressing the Indian Growth Accelerator; Policy Imperatives

India’s real GDP growth slipped substantially after the North Atlantic financial crisis. Return to a sustained high growth trajectory is feasible but it will need much more focused attention to the revival of manufacturing and to the acceleration of investment in transport and infrastructure. The immediate priority is to achieve the kind of fiscal quality and low inflation levels exhibited during 2003-08, with focused attention to increasing efficiency and compliance in tax revenue collection. Higher tax revenues can facilitate increases in public investment, which then crowd in private investment. The task ahead will be more difficult in view of the protracted slowdown in global growth and trade.

Inflation Forecasting: Issues and Challenges in India

This paper focuses on modelling and forecasting inflation in India using an augmented Phillips curve framework. Both demand and supply factors are seen as drivers of inflation. Demand conditions are found to have a stronger impact on non-food manufactured products inflation (NFMP) vis-a-vis headline WPI inflation; moreover, NFMP is found to be more persistent than headline inflation. Both these findings support the use of NFMP as a core measure of inflation. But, the impact of global non-fuel commodities on NFMP is found to be substantial. Inflation in non-fuel commodities is seen as a more important driver of domestic inflation rather than fuel inflation. The exchange rate pass-through coefficient is found to be modest, but nonetheless sharp depreciation in a short period of time can add to inflationary pressures. The estimated equations show a satisfactory in-sample as well as out-of-sample performance based on dynamic simulations. Nonetheless, forecasting challenges emanate from volatility in international oil and other commodity prices and domestic food supply dynamics.

Liquidity Management and Monetary Policy: From Corridor Play to Marksmanship

From January 2014, the Reserve Bank of India (RBI) initiated a regime change in the conduct of monetary policy. Under its revised liquidity management framework, the operating target - the weighted average call money rate -has moved in a tight range of +/−40 bps with the long-run coefficient on the effective policy rate close to unity. Autoregressive distributed lag model estimates indicate that 74 % of the deviation of the call rate from the policy rate is adjusted in just one day in the most recent period as against only 24 % in earlier periods. Various segments of the money market are getting increasingly integrated and confirm a martingale process. A marked reduction in volatility in the operating target is validated by an I-GARCH (1, 1) model, though volatility brought on by large exogenous shocks appears regime-insensitive.