One year and five months after it got into “flexible inflation targeting” mode, India is set to formally adopt a consumer price inflation (CPI) target of 4+/-2%. Under an agreement between the government and the Reserve Bank of India signed in February 2015, the same target has already been pursued since FY16, while the RBIcomfortably achieved its internal retail inflation target of 5.8% for January 2016. A gazette notification giving legal backing to the target, the notion of price stability as the primary objective of monetary policy and a defined Monetary Policy Framework, was about to be issued soon, sources said late on Friday.
The move is despite many analysts, including those from within the government like Niti Aayog’s Arvind Panagariya, opining that a 2% floor for CPI inflation appeared to be too low and needed to be revisited given the imperative of higher economic growth. With inflation inching up recently — retail inflation rose to a 22-month high of 5.77% in June as food inflation remained elevated due to an intense and prolonged summer — former RBI governor D Subbarao doubted the feasibility of the central bank achieving its 4% CPI inflation target by January 2018 and in his book, ‘Who moved my interest rate’, wrote: “The world over, there is a rethink on its advisability (of inflation targeting). Global experience shows that an inflation-targeting framework is neither necessary nor sufficient to maintain price stability.”
However, the government is clearly moving ahead with the new policy paradigm. Sources said that three experts — Manoj Panda, director, Institute of Economic Growth; Rajiv Kumar, senior fellow at the Centre for Policy Research; and Rathin Roy, director, National Institute of Public Finance and Policy — would be part of a search-cum-selection committee headed by the Cabinet secretary to help government appoint three members to the proposed Monetary Policy Committee. The other three members of MPC will be from the RBI namely the governor — who will also be the ex-officio chairperson — the deputy governor in charge of monetary policy and one officer of RBI. Each member of the MPC will have one vote, while the governor will have a second or casting vote in case of a tie.
In June, the Centre had notified the amendments to the Reserve Bank of India Act, 1934, pertaining to the MPC. With a view to maintaining price stability and keeping in mind the objective of growth, the RBI Act was amended by the Finance Act, 2016, to provide for a statutory and institutionalised monetary policy framework. However, the target rates haven’t been notified and so the gazette notification now. Currently, the RBI governor is the final arbiter on interest rates.
The government would try to name the three members in the MPC as soon as possible, a source said. These three members of MPC will be experts in the field of economics or banking or finance or monetary policy and will be appointed for a period of 4 years and won’t be eligible for reappointment.
The RBI has has set for itself a CPI inflation target of 5% by March 2017. Under the MPC framework, it will also be stipulated that in the event of a failure to sustain the retail inflation at the prescribed levels in three consecutive quarters, the RBI will report to the government on the reasons for the deviation, remedial action and estimated time within which the target will be achieved.
Even as the headline number notched up, core CPI-based inflation remained rather subdued at 4.5% in June. So a good spread and quantum of rainfall, as forecast, could prompt the RBI to effect a 25-basis-point cut in the benchmark lending rate in the third quarter of 2016-17, if not in the next monetary policy review meeting in August, many analysts feel. Although monthly movements remained volatile at times, CPI inflation, on an annual basis, eased substantially from 9.9% in 2012-13 and 9.4% in 2013-14 to 5.9% in 2014-15 and 4.9% in the last fiscal.
