Money & Banking

Current inflation target band appropriate for the medium term: RBI report

Our Bureau Mumbai | Updated on February 26, 2021

Maintaining the inflation target at 4 per cent into the medium-term is appropriate, according to the Reserve Bank of India’s Report on Currency and Finance (RCF) for 2020-21.

Trend inflation

This observation is significant as it comes in the backdrop of the upcoming review of the inflation target of 4 per cent, with upper tolerance level of 6 per cent and lower tolerance level of 2 per cent.

The comment is based on the observed softening in trend inflation since 2014 and a decline in inflation persistence.

The report said: “Threshold inflation above which growth is unambiguously impaired ranges 5-6 per cent in India, indicating that an inflation rate of 6 per cent is the appropriate upper tolerance limit for the inflation target. “On the other hand, a lower bound above 2 per cent can lead to actual inflation frequently dipping below the tolerance band while a lower bound below 2 per cent will hamper growth, indicating that an inflation rate of 2 per cent is the appropriate lower tolerance bound.”

Under Section 45ZA of the RBI Act1934, the Centre, in consultation with the central bank, fixed the inflation target/Flexible Inflation Target (FIT) for the period between August 5, 2016 and March 31, 2021, at 4 per cent, with upper tolerance level of 6 per cent and lower tolerance level of 2 per cent. “Trend inflation to which actual inflation converges after a shock provides an appropriate benchmark for the inflation target; trend inflation has fallen from above 9 per cent before FIT to a range of 3.8-4.3 per cent during FIT, indicating that 4 per cent is the appropriate level of the inflation target for India,” the report emphasised.

Monetary policy

Batting for the continuation of the existing monetary policy framework, the report underscored that the institutional architecture of FIT, including the size of the Monetary Policy Committee (MPC) and its composition, the decision-making process, communication practices, and accountability mechanisms is in line with international best practices.

However, the definition of the time horizon of failure (defined as three consecutive quarters of average headline inflation over/under-shooting the upper and lower tolerance levels around the target), processes of onboarding of MPC members, some aspects of forward guidance and timings relating to release of minutes, shut periods and release of transcripts warrant a review.

Price stability

The report noted that the primary focus of FIT on price stability augurs well for further liberalisation of the capital account and eventual internationalisation of the rupee.

“In the conduct of monetary policy in an open economy setting, foreign exchange reserves and associated liquidity management are key; hence, there is a need to enhance the RBI’s sterilisation capacity to deal with surges in capital flows,” the report said.

Published on February 26, 2021

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

This article is closed for comments.
Please Email the Editor

You May Also Like