Monetary policy objective under FIT regime helps avoid undue volatility in rate setting behaviour: Das

The flexible inflation targeting (FIT) framework has allowed the Monetary Policy Committee (MPC) to continue with the accommodative monetary policy stance in support of growth, according to Reserve Bank of India Governor Shaktikanta Das.

MPC persisted with the accommodative monetary policy stance even as inflation intermittently touched or exceeded the upper end of the inflation band due to large supply shocks and other bottlenecks.

The aforementioned observations of the Governor came in the backdrop of expectations in some quarters that RBI may bring forward rate hikes to stem the inflationary effect of high crude oil prices and a depreciating Rupee amid indications that the US Fed is set to hike rates. 

“The flexibility in the FIT regime comes from provisions to accommodate or see-through transitory supply side shocks to inflation. The framework’s flexibility and efficacy were tested significantly in the past couple of years as we have been grappling with the once in a century crisis, the Covid-19 pandemic,” Das said in his address at the National Defence College, New Delhi.

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Unconventional measures

The Governor also highlighted that RBI, as part of its pandemic response, has undertaken unconventional measures even before exhausting the conventional policy space — that is even before reaching the zero lower bound of interest rates.

At its last meeting, the MPC kept the policy repo rate unchanged at 4 per cent as the ongoing domestic recovery was still incomplete and needed continued policy support. The committee noted that inflation is likely to moderate in H1:2022-23 and move closer to the target rate thereafter, providing room to remain accommodative.

Retail inflation based on Consumer Price Index (CPI) crossed the MPC’s upper tolerance limit of 6 per cent in January 2022 even GDP growth in the third quarter was relatively muted.

Retail inflation reading came in at 6.01 per cent in January 2022 as against 5.6 per cent in December 2021. GDP growth slowed to 5.4 per cent in the October-December 2022 period against 8.5 per cent in July-September period.

“...We have continued with our accommodative stance based on our own domestic growth-inflation dynamics, amidst current divergence in policy actions of central banks across the world. Thus, we have used the flexibility embedded in the FIT framework and implemented our monetary policies, without compromising on our primary mandate of price stability,” the Governor said.

Das observed that the failure to meet the monetary policy objective is defined in terms of average headline CPI inflation remaining lower or higher than the 2 to 6 per cent band for three consecutive quarters, rather than any instance where inflation exceeds / falls below the target.

“This helps monetary policy to avoid undue volatility in rate setting behaviour that may adversely impact growth,” he said.

Central banks in a bind

The Governor underscored that central bankers are in a bind– if they act aggressively to contain inflation which may perhaps subside as normalcy returns, they run the risk of setting in recession; on the other hand, if they act too little and too late, they may be blamed for “falling behind the curve” and may have to do a lot of catching up later which will be detrimental to growth.

Das said financial markets world over have turned extremely volatile as they have been left grappling with heightened uncertainty over the pace of future monetary policy normalisation.

Recent geo-political developments have further aggravated the challenges and dilemmas for the central banks, he added.

The Governor explained that amidst these uncertainties, central banks have to find the optimal grounds with attendant communication challenges.

“...Unwinding of open-ended policies, as and when they happen, would require careful, nuanced and measured communication as in such instances, the expectations of certain segments of the market may not be in sync with that of the central bank’s assessment.

“Most of our measures were announced with pre-set terminal dates instead of being open-ended. This has reinforced the credibility of our announcements,” Das said.

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