Inflation targeting: Govt has 5 months to decide on new regime

Shishir Sinha New Delhi | Updated on November 16, 2020

Experts feel one-off events like the pandemic should not influence target resetting

With the inflation keeping above the RBI’s comfort level and staying the central bank’s hands on cutting policy rates, the debate has been around the inflation-targeting framework. The discussion will only gather more heat as the current five-year regime is to end on March 31, 2021. That leaves the government less than five months to either set a new target or maintain status quo.

“No call has yet be taken on the new range or to continue with the existing range of 4 per cent (with a 2 percentage point swing in either direction),” a senior Finance Ministry official told BusinessLine. Asked if it is the current economic situation or some other reason that is delaying the process, the official said that a number of factors need to be considered before arriving at a new range to be followed from April 1, 2021 or deciding to continue with the existing range.

However, experts feel that the present range should be continued.

Flexible target

In May 2016, the Reserve Bank of India  Act, 1934 was amended to provide a statutory basis for a flexible inflation targeting framework. The amended Act also provides for the inflation target to be set by the Government, in consultation with the RBI, once every five years. Accordingly, the Centre had notified in the Official Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021, with the upper tolerance limit of 6 per cent and a lower limit of 2 per cent.

Anil K Sood, Professor at Hyderabad-based Institute for Advanced Studies in Complex Choices (IASCC), feels inflation targeting is a forward-looking idea and, therefore, it is important to recognise that the use of historical data is only a proxy for expected inflation levels. The targeting is meant to anchor the medium- to long-term inflation expectation and its volatility. Consequently, any event (for instance, the Covid pandemic) or seasonal variation in inflation would be of limited concern.

“We don’t even want the RBI to start responding to short-term, seasonal or event-determined variations in inflation, as that would introduce unnecessary volatility in interest rates increasing the probability of resource mis-allocation, in turn,” he said.

Growth dynamics

Echoing the same sentiment, Sunil Kumar Sinha, Principal Economist with India Ratings & Research, said inflation targets are not decided by the events of the recent past. Therefore, setting the inflation target to be followed from April 1, 2021 should not be a problem.

Published on November 16, 2020

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