Does RBI’s inflation band need a relook?

K Srinivasa Rao | Updated on: May 15, 2022
RBI: Grappling with the inflation demon

RBI: Grappling with the inflation demon | Photo Credit: FRANCIS MASCARENHAS

The target of 4% with a 2% band either way may appear too restrictive, given today’s situation. RBI needs more elbow room

As expected, the CPI inflation is at a new high of 7.79 per cent in April moving up from 6.95 in March and 6.07 per cent in February. The wholesale price index (WPI) is equally scary at 14.55 per cent in March.

Apprehending the inevitable spike in inflation, RBI already intervened on May 4 to hike repo rate by 40 basis points and raised CRR by 50 basis points affirming its intent to fight raging inflation just before US Federal Reserve went for second rate hike.

But the RBI needs to move carefully. Central banks across the globe are working hard to curb inflation, using policy rate hikes and tapering liquidity.

The consequential tantrums impact the foreign investment traffic to the detriment of emerging economies. The reverse flow of foreign investments creates exchange rate volatility that adds to the woes of central banks.

The war between Russia and Ukraine and stiffening sanctions against Russia, a formidable trade partner for India, is not showing any sign of resolution in the near term.

On the other end, despite near normal monsoon forecast, the weather has been uncertain and harsh arising from climate risks. The untimely cyclonic storms, rains, hailstorms, intense heatwaves, recirculating viruses will tend to adversely impact foodgrain production, cash crops, vegetables, fruits and horticulture, floriculture, that will have lingering impact on the food prices.

With no sign of any abatement of inflation headwinds, the economy should prepare for a long fight. The enterprises have to understand the dynamics of persistent inflation and prepare to manage risks arising from rising input costs. They need to find alternate improved operational efficiencies with the help of technology to marginalise the impact of input costs by improving processes and logistic costs. Enduring inflation and yet ensuring growth should be the new tack of entrepreneurs and other stakeholders.

Possible policy reform

While the fight with inflation is on, there has to be a policy debate on whether the glide path of inflation -- plus/minus 2 percentage points of inflation over 4 per cent (inflation range set between 2 to 6 per cent) set by Dr Urjit Patel Committee in 2014 — that culminated in the adoption of inflation targeting framework (FIT) in India is the right target now.

Logically, the learned committee could not have envisaged eruption of ‘once in a century kind of pandemic’, impacting the glide path of inflation. The RBI report on Currency and Finance 2022 clearly indicated a stretched time period to normalise growth till as late as 2034-35; it may be difficult in the intervening convulsing period for the central bank to retain inflation within the normal band.

The economy with its traditional inflation fighting tools designed in the pre-pandemic context suddenly found itself hard put to fight a different kind of inflation war, mounted by pandemic shock and the prevailing geopolitical storm. The RBI is expected to explain to the Parliament any failure to manage inflation within the FIT if it breaches in three consecutive quarters.

Since the FIT standards were set without factoring the catastrophic impact of twin protracted calamities, a debate could be considered to temporarily change the inflation targets — extend the period of deviation to two years so that the central bank can get an opportunity to simultaneously work for growth and inflation control.

It will be too much to expect the central bank to maintain the same inflation target when the whole operating ecosystem has gone haywire. When the economy can withstand a 6 per cent inflation, it has to learn the nuances of putting up with higher inflation for some time till the major risks of pandemic slowdown and restoration of peace are effectively tackled.

India is however working steadily to restore peace in its own way; some of the high frequency indicators demonstrate the speed with which the economy is striving to catch up growth. A compatible policy support could strengthen the resilience. It could possibly hasten the revival of the economy, given the need to navigate through the extraordinary crises whose dimensions are still not measurable. Besides RBI doing its task, timely policy intervention from the government could help the economy withstand the travails of elevated levels of inflation in near term.

The writer is Adjunct Professor, Institute of Insurance and Risk Management – IIRM. The views are personal

Published on May 15, 2022
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