Economists welcome the Urjit Patel monetary policy committee’s recommendation that the RBI shift to inflation targeting — with a 4 per cent CPI inflation target in two years as a positive move.
Late Tuesday evening, the RBI’s monetary policy committee (MPC) said the central bank would try to bring down inflation gradually to 8 per cent from 10 per cent over the next 12 months and to 6 per cent over the next 24 months before formally adopting the 4 per cent recommended target.
According to Indranil Sen Gupta, economist with Bank of America Merrill Lynch, “The operating target will also gradually shift to the 14-day repo rate from the overnight call rate. The RBI will continue to manage liquidity and meet the demand for liquidity from the banking system using a mix of term repos, overnight repos, OMOs and the MSF. On balance, we see the RBI’s shift to inflation targeting as a step in the right direction.”
However, the time span over which it could be achieved will vary with a number of factors, such as, the rains or the global growth cycle or oil prices. We continue to expect the RBI to pause on January 28 as CPI is expected to further come off in January on falling inflation, Gupta said in a report.
The report highlighted that inflation should be the nominal anchor for the monetary policy and that the anchor should be communicated ‘without ambiguity’ to ensure a shift from the past multiple-indicator framework. The importance of monitoring inflationary expectations also received a mention and its entrenched nature was the key reason why inflation was high despite disinflationary impulses from weak growth.
Gupta’s report sees CPI inflation coming off towards 9-9.5 per cent in January and 7.3 per cent by March 2015 assuming normal rains and stable oil prices, not very different from the RBI Committee's projected CPI inflation path over the next year.
Fiscal deficit target
The committee has also called on the Government to fulfil the fiscal goalposts, especially narrow the fiscal deficit to GDP ratio at 3 per cent of GDP by 2016-17.
According to Radhika Rao, Economist, DBS Group, “An inflation targeting regime also brings the RBI’s policy calibration closer to international practices. In the immediate term, given that the headline CPI inflation stands at 9.9 per cent above the repo rate and the recommended 12-month target of 8 per cent, a case for a rate hike can be made.”
The RBI will target a 4 per cent CPI inflation target (with +/-2 per cent band) in two years. Since food and fuel account for more than 57 per cent of the CPI on which the direct influence of monetary policy is limited, the commitment to the nominal anchor would need to be demonstrated by timely monetary policy response to risks from second-round effects and inflation expectations in response to shocks to food and fuel.
“The impact and cohesiveness with the fiscal policy also needs to be put into place before embarking on a full-fledged inflation targeting framework,” Rao added.