Right balance

There is little doubt that the experiment of the last five years with inflation targeting through the Monetary Policy Committee has worked. Inflation was fairly benign at 3.9 per cent in the period between October 2017 and March 2020 compared to the 8-9 per cent levels of the early part of this decade. It is therefore welcome that the RBI and the Centre are considering continuation of the Flexible Inflation Targeting (FIT) mechanism for another five years. Price stability is critical to protect the value of money and to encourage financial savings that in turn give an impetus to capital formation in the economy. Yet, in a bid to control inflation, the central bank should not lose sight of the need to promote growth. The RBI has, de facto, followed a multiple-indicators approach in the last couple of years — first when the economy started slowing in 2018-19 and then during the pandemic, and rightly so too. Considering that quantifying growth targets is more difficult than projecting inflation targets, most central banks work with FIT to anchor their monetary policy. The RBI is not wrong to follow this practice but it should continue to give precedence to growth over inflation control when the conditions demand, as was the case over the past one year.

That said, it is up for debate over whether the RBI is right in maintaining the existing band for another five years. The RBI’s Report on Currency and Finance has recommended that the current band for preferred CPI-C inflation between 2 and 6 per cent can be continued. The RBI has probably gone by its experience of the last five years with benign inflation. A robust agri output had kept food inflation low while tapering global growth had helped keep fuel prices under check. Volatility in inflation was also quite muted in this period. But consumer price inflation has been quite high, above 6 per cent, for most part of FY21 as the pandemic disrupted supplies of consumer staples. With the economy yet to completely recover, such disruptions are likely to continue. Further, increasing crude oil prices are set to drive the headline number higher. The central bank could have considered increasing the upper band, to give itself more leeway to maintain easy monetary policy.

The central bank also needs to reassess the combined CPI number used for inflation targeting. The weight for food in the headline CPI index, at 46.2 per cent, is the highest globally, and is the primary reason for the inflation in India being much higher than other countries. There is a strong case for revising the weight for food lower. The index weights have not been revised over the past decade and are based on the Consumer Expenditure Survey conducted in 2011-12. With inflation targeting set to guide policy over the next few years, it is critical that the numbers used are credible.

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