Why the drama? Set interest rate automatically.

There is passionate, almost religious, belief among politicians, civil servants and economists in India that interest rate should be extremely low, regardless of inflation, because low borrowing cost will encourage new investment, creating new jobs and resulting in growth of the economy. The government has committed to a target inflation rate of 4%, plus/minus 2%, giving a ridiculously wide band of 2-6% for the new Monetary Policy Committee to play with. Previously, calculation of inflation was based on wholesale prices but since 2014 the RBI decided to base its policy on the new Consumer Price Index, or CPI. Since then, there has been a heated debate about whether CPI should be the guide for prices in India since food and fuel are major constituents in its calculation or whether we should use core inflation which discounts these 2 volatile elements. Karthik Shashidhar has analysed the various components of the CPI basket and has cast doubts on its accuracy because real estate prices, which have a linear relationship with CPI, are not included in its calculation. Rent has the highest weight of 10.07% in calculating CPI. It is misleading because rent constitutes 21.7% of urban CPI but is not a part of rural CPI, because people do not rent in villages. Shashidhar writes that a higher interest rate deters people from buying real estate for investment purposes which reduces the supply of housing for rent and people, who are looking to buy a property for personal use, postpone their purchase. These 2 factors should cause a rise of rents and result in higher CPI. Raising interest rate increases spending on goods purchased through borrowing, which reduces spending on other goods as services, and so brings down prices generally. Shashidhar has compared the rise in prices of real estate with the rise in CPI since August 2011 and has shown a linear relationship between the two. He concludes that the present CPI is suspect because it incorporates rent but not the rise in sale price rise of real estate. But, his study actually supports the way CPI is calculated. If the price of real estate is directly related to CPI then a fall in its value by raising interest rate will control inflation. Secondly, those who can afford to buy properties at these prices are not bothered by a rise in the price of food or fuel but those who have to pay rent are very sensitive to rising prices. The previous governor of the RBI, Raghuram Rajan was treated with disrespect because he argued for a real interest rate of 150-200 basis points. Instead of maligning the RBI politicians should get rid of the MPC and take direct responsibility. Declare the real interest rate they want to maintain and adjust interest rate automatically every 2 months to the corrected CPI. That way we will know who to blame.