Economy

In monetary policy rejig, India moves to inflation targeting

Shishir Sinha NEW DELHI | Updated on March 09, 2018

page 1.jpg

RBI

Central bank, govt sign pact on inflation targeting

In a major monetary policy shift, India has adopted inflation-targeting.

A Monetary Policy Framework Agreement, signed by the Centre and the Reserve Bank of India on February 20 but made public on Monday, veers round to Raghuram Rajan’s view that India too should move towards inflation targeting, which is common in developed economies. Currently, the Centre and the RBI give inflation estimates, but don’t set targets.

Now, the Framework Agreement says, “the Reserve Bank will aim to bring inflation below 6 per cent by January 2016. The target for financial year 2016-17 and all subsequent years will be 4 per cent with a band of +/- 2 per cent.” The agreement also said the Governor and in his absence the Deputy Governor (in charge of monetary policy) will determine the policy rate, as well as any other monetary measures, to achieve the target.

The inflation here is the Consumer Price Index (CPI) or retail inflation. Post the Centre revising the base year for retail inflation to 2012 from 2010, the CPI for January 2015 was 5.11 per cent, which is almost flat compared to 5 per cent in December.

The Agreement, in line with the recommendations of the RBI’s Urjit Patel committee, will smoothen the monetary policy scene. It will provide a predictable policy stance on inflation, helping investors, especially in the debt market.

The Agreement also binds the Centre to taking proactive measures for price control. The country has suffered the vagaries of price volatility because of, one, its big reliance on imports for fuel and, two, the farm sector’s dependence on the monsoon.

The large fiscal deficits because of the Centre’s borrowings to fund its spending too have impacted inflation.

RBI affair, no more

Traditionally, monetary policy formulation is a closed-door RBI affair. But, with the new framework, a committee will take a call on the policy prescription, which the central bank will implement. Based on the recommendations of the Financial Sector Legislative Reforms Commission, the committee will comprise the RBI Governor, a Deputy Governor (in-charge of monetary policy), a Union Government nominee, and five independent members. The committee will vote on its decision, but the government nominee does not get a voting right.

Achieving policy targets

On the process of monetary policy-making, the Agreement said the RBI will put out an operating target and establish a procedure to achieve this target. Any change in the operating target and the procedure in response to evolving macro-financial conditions will also be published. Once every six months, the RBI will explain about the source of inflation besides giving forecasts for six-18 months.

“The RBI will be seen to have failed to meet the target if inflation is more than 6 per cent for three consecutive quarters for the financial year 2015-16 and all subsequent years,” the Agreement said.

The RBI will give a report to the Centre if it fails to meet the target. In a note to their clients, Nomura’s Sonal Varma and Aman Mohunta said that given India’s history of high inflation, 4 per cent as the mid-point CPI target in the medium term does appear optimistic, but this could perhaps be achieved through a coordinated effort between the RBI and the Centre.



Published on March 02, 2015

Follow us on Telegram, Facebook, Twitter, Instagram, YouTube and Linkedin. You can also download our Android App or IOS App.

null
This article is closed for comments.
Please Email the Editor